The author, in collaboration with Jack Bakken, ASA, analyzed eleven ski area sales for the U.S. Forest Service during the summer and fall of 1992. While the specific sales and income data are confidential to protect the privacy of the individual ski areas, there is still a wealth of information that can be released. Part 1 of this two-part series discusses the principles of land value and what creates ski area land value. The study methodology is also described. Part 2 will identify four indicators of market value, and using these sales, plus data on four additional sales, will establish a reasonable range of projection parameters. — The Editors
The only true way to discover the value of the land is to sell it under competitive bidding. The challenge of this analysis was to achieve a result that adequately compensates the government for the use of the public lands while still maintaining the potential for entrepreneurial gain in relation to the risks. Different sites will have different values due to the productivity of the land, whereas different ski areas will have different values due to the ability of the entrepreneur.
Appraisers define two “rent” concepts. They are “market rent”—the fee paid for the use of land and/or other assets as determined by the free interplay of the market; and “contract rent”—the fee paid according to a fixed agreement. In the beginning of a landlord/tenant relationship the two may be the same. However, as time passes, and as new competition or changes in demand or other economic factors impact the market place, market rent may change, while contract rent remains fixed at the original terms.
The USFS graduated rate fee system (GRFS) was installed some 25 years ago. Controversial at that time, it gradually became the accepted norm. At some point, both the government and most ski area operators on public land perceived this system as fair, and thus market rent equaled contract rent. However, recent sales of ski resorts, together with new interpretations of the terms and wide regional differences in contract administration, have conspired to create major differences between the market rent and the contract rent for the use of government land.
Our methodology is based on the implied fact that all eleven transactions occurred based on a known “contract rent.” That is, all buyers were familiar with the USFS permit terms and their purchase decision was based on their need to create adequate returns after payment of the existing contract rent, whether or not it was “fair.” Thus, if the existing GRFS formula created a fee payment that was judged too high for the productivity of the site, the buyer would offer a lower price to even out the perceived excessive contract rent. On the other side, if the existing GRFS formula created a fee payment that was judged favorable, the buyer would offer a premium that, among other things, recognized the existence of a “below market” contract rent.
In most transactions I doubt whether the USFS fee payments were specifically evaluated; however, the price paid for the specific ski area relative to the value of the existing hard assets, and a reasonable marketable intangible value (goodwill etc.), yields a residual that implies the buyer’s perceived value of the site.
We arrived at this value using a five-step process and a comparable calculation to first adjust the purchase price by eliminating non-ski resort assets and then allocating the remainder.
1. Identify and eliminate all parts of the sales transaction that are surplus to the basic ski area, such as private development land parcels, private commercial and/or residential properties and related but separate businesses, such as downtown ski shops and resort central reservation services.
2. Create a stabilized historic operating statement to factor out unusual one-time occurrences and average the critical weather variable. We created this stabilized income statement by using the three seasons prior to the sale and adjusting the income and expense by the consumer price index to the year of the sale.
3. Create a depreciated replacement cost estimate of the hard assets. We subcontracted the estimating of ski lift cost to Jenlynn International, and snowmaking system costs to Delta Engineering. Building replacement cost and depreciation estimates were done using the Marshall Swift manual, and all other costs were accomplished in-house. We hired Winston Associates, environmental planners, to assist in substantiating the probable cost of planning and environmental impact studies. This step provided the second major judgment.
4. Determine what, if any, allowance had to be made to replace assets that were worn, obsolete or missing. We thereby provided an estimate to correct functional utility.
5. The final step was to use these facts and judgments to determine the “fair market” value of the land.
Since the buyer purchased the ski resort subject to a known contract rent for the use of the public land (the GRFS fee schedule), the value of the land becomes the capitalized value of the annual fee at the purchaser’s overall rate plus or minus the difference between his purchase price and the reasonable depreciated replacement cost. When there is no difference, the contract rent and the market rent are equal. When the depreciated replacement costs exceed the purchase price, the contract rent is too high (i.e. above market rent); and when the reverse occurs, the contract rent may be too low (i.e. below market rent). The word “may” is used because in this instance I believe there is also some intangible business value that is marketable.
Therefore, when the purchase price is below the depreciated replacement cost, the new owner has downgraded the value of the ski area business at this site. Conversely, when the price exceeds the depreciated replacement cost, the new owners have assigned excess value to the ski area business at that site.
We thus developed an allocation system that is based on the following logical buyer/seller motivations:
- All buyers paid the least amount possible and all sellers asked the largest amount possible.
- All buyers purchased the assets or stock with the full knowledge that the existing contract rent obligation (GRFS fee) would be part of the purchase.
- Therefore, USFS permits where the existing contract rent was below the buyer’s perceived value, resulted in premium prices; in the reverse, additional discounts resulted.
- The value of the physical assets can be reasonably determined by preparing an estimate for depreciated replacement cost; further, that it would be appropriate to provide an additional influx of capital to correct deferred maintenance and/or replace worn or obsolete equipment in order to preserve historic earning power.
- All buyers had a target return in mind and we can estimate that return by creating a stabilized net operating income (NOI) and determining the resulting overall rate by dividing this stabilized NOI by the effective sale price (i.e., adjusted sale price plus funds to maintain functional utility).
There are three critical differences in the eleven sales: a) utilization rate; b) revenue per skier-visit; and c) cash operating costs. In general, the higher the utilization rate and the higher the revenue-per-skier, the better the net operating income. Cash operating expenses do not increase proportionately with revenue.
It is our observation that if the derived sales price is equal to the hypothetical value, the contract rent is equal to the market rent. (Derived sales price is arrived at by adding three “buyer-set” values; hypothetical value is arrived at by adding the depreciated replacement cost to the amount required to maintain functional utility and the capitalized value of the annual fee.)
Applying Classic Economic Theory to Ski Area Land Values
Classic economic theory establishes four agents of production: land, labor, capital and management (coordination). Economic principles are based on achieving a balanced reward for all these factors of production. In our free enterprise system the laws of supply and demand will interact to reward or punish by the adequacy of the returns to each of these factors. Equilibrium is the goal. In order for a property to have value, four independent economic factors must be present: utility, scarcity, desire and effective purchasing power.
Addressing utility, ski areas require a critical combination of favorable physical and economic factors in order to be successful. A good site must offer an attractive mountain with appropriate exposure, abundant snow cover and/or adequate water and power to make it, varying tree cover, minimal geological hazards, protection from wind and sun …
| Line Item | Formula | Inferior | Superior | Neutral | |
|---|---|---|---|---|---|
| A | Size: VTF/hr (000) | 8,750 | 8,750 | 8,750 | |
| B | Skiable Acres | 500 | 500 | 500 | |
| C | Permit Acres | 1,500 | 1,500 | 1,500 | |
| D | Private Acres | 200 | 200 | 200 | |
| E | TOTAL ACRES | 1,700 | 1,700 | 1,700 | |
| F | Skier Capacity | 5,000 | 5,000 | 5,000 | |
| G | Days of Operation | 130 | 130 | 130 | |
| H | Capacity Skier-Visits | (F x G) | 650,000 | 650,000 | 650,000 |
| I | Stabilized Skier-Visits | 162,500 | 325,000 | 260,000 | |
| J | UTILIZATION: | (I / H) | 25% | 50% | 40% |
| K | REVENUE / SKIER-VISIT | $25.00 | $35.00 | $30.00 | |
| L | Gross Revenue (000) | (I x K) | $4,063 | $11,375 | $7,800 |
| M | GROSS REVENUE MULTIPLIER | 0.9 | 1.8 | 1.3 | |
| N | Stabilized Net Operating Income (000) | $400 | $2,275 | $1,189 | |
| O | OVERALL RATE | (P / Z) | 10.88% | 10.88% | 10.88% |
| P | REPLACEMENT COSTS (000) JUDGMENT | $25,000 | $25,000 | $25,000 | |
| Q | Average Age – Years | 24 | 24 | 2 | |
| R | DEPRECIATED REP. COST (000) JUDGMENT | $10,000 | $10,000 | $10,000 | |
| S | USFS Fee: Rate | 1.77% | 2.69% | 2.19% | |
| T | Dollars (000) (Contract Rent) | $72 | $306 | $171 | |
| U | VALUE (000) @ OVERALL RATE | $662 | $2,813 | $1,572 | |
| V | Adjusted Sale Price (000) | $2,176 | $20,910 | $10,176 | |
| W | Plus: Functional Utility JUDGMENT | $1,500 | $0 | $754 | |
| X | Effective Sales Price | (X + Y) | $3,676 | $20,910 | $10,930 |
| Y | Plus: Land Value GRFS | (W) | $662 | $2,813 | $1,572 |
| Z | Derived Sales Price | $4,338 | $23,722 | $12,502 | |
| AA | Less: Dep Replacement Costs | $10,000 | $10,000 | $10,000 | |
| AB | Functional Utility | $1,500 | $0 | $754 | |
| AC | RESIDUAL VALUE | ($7,162) | $13,722 | $1,748 | |
| MARKET BASED APPROACH | |||||
| R | Depreciated Rep Cost | (000) | 81.7% / $10,000 | 76.2% / $10,000 | 80.0% / $10,000 |
| W | Plus: Functional Utility | (000) | 12.3% / $1,500 | 0.0% / $0 | 6.0% / $754 |
| Y | Plus: Land Value GRFS | (000) | 5.4% / $662 | 21.4% / $2,813 | 12.6% / $1,572 |
| AD | Plus: Land Value Private | (000) | 0.6% / $74 | 2.4% / $313 | 1.4% / $175 |
| AE | Hypothetical Value | (000) | 100.0% / $12,235 | 100.0% / $13,125 | 100.0% / $12,500 |
| ALLOCATION: | |||||
| AF | Derived Sales Price | (000) | 100.0% / $4,338 | 100.0% / $23,722 | 100.0% / $12,502 |
| AG | Land (MARKET) | (000) | 6.0% / $261 | 23.8% / $5,648 | 14.0% / $1,747 |
| AH | True Asset Value | (000) | 94.0% / $4,078 | 42.2% / $10,000 | 86.0% / $10,754 |
| AI | Intangible Value | (000) | 0.0% / $0 | 34.0% / $8,074 | 0.0% / $1 |
| AN | VALUE per ACRE | (AG / E) | $153 | $3,322 | $1,027 |
Explanation of the Table
Three scenarios are shown for ski areas with exactly the same scope: inferior, superior and neutral. Lines A through H are identical. Lines I and J illustrate the three possible utilization rates, and line K the most likely revenue parameters. Thus gross revenue varies from a poor $4-plus million to an excellent $11-plus. Net operating income varies from a poor $400,000 (9.8 percent operating margin) to an excellent $2,275,000 (20 percent operating margin).
The replacement costs and depreciated replacement costs are identical (Lines P and R).
The existing USFS fee will vary slightly between 1.77 percent and 2.69 percent of gross revenue, with the higher figure for the “superior” scenario. We need to capitalize this annual fee to obtain the present value of the annual income stream at the same rate that the buyer used to establish an offer, namely the 10.88 percent overall rate (Line O). The effective sale price is based on each scenario yielding an overall rate of 10.88 percent. Part of the effective sale price is the actual price paid (the adjusted sale price) and part an allowance for maintaining functional utility.
Now all the tools are in place for determining the true fair market value of the site (land). The first step is to calculate the residual by subtracting the depreciated replacement cost (Line AA) and the budget to maintain functional utility (Line AB) from the derived sales price (Line Z). The residual is shown on Line AC.
- The inferior scenario has a negative residual, meaning there is no marketable intangible value; further, the market value of the land is less than the value obtained by capitalizing the contract rent.
- The superior scenario has a positive residual value that is greater than the capitalized contract rent value, indicating that both the capitalized contract rent value is too low a value, and further that there is some marketable intangible value.
- The neutral scenario has a positive residual value that is equal to the capitalized contract rent value, indicating that market rent equals contract rent and that there is no marketable intangible value.
The second step is to create a hypothetical value by adding the depreciated replacement costs, the budgeted costs to maintain functional utility and the capitalized contract rent. This hypothetical value is then used to determine the proportion of the derived sale price to allocate to the land (Lines Y and AD).
The final step is to apply this proportion to the derived sale price—the market value of the ski resort—(Line AG).
Note that in the neutral scenario the capitalized contract rent figure of $1,572,000, plus the capitalized value of the private land at $175,000, equals $1,747,000—the calculated market rent (Line AG). Thus “contract” rent equals “market” rent.
In the inferior scenario, the $735,000 capitalized contract rent figure is only six percent of the hypothetical value; when applied to the much lower derived sale price, it reduces the site (land) value to $261,000.
In the superior scenario, the $3,126,000 capitalized contract rent figure is a whopping 23.8 percent of the hypothetical value; when applied to the much higher derived sale price, this increases the site (land) value to $5,648,000. Then the intangible value becomes the residual at $8,074,000.
In the example, the per-acre site or land value varies from $3,322 to $153. It is important to note that appraisers are charged with interpreting market value by applying reasonable judgments and methods in a comparable manner. Market value, on the other hand, is created by the free interplay of buyers and sellers.
I have subsequently found this methodology of value in allocating appraised value between hard assets and land.
