Vacancy/Concessions

Vacancy in most submarkets in the PMA has increased since the end of 2008. Most of PGP’s recent survey’s show vacancy typically in the 5-8% range for stabilized properties. Most managers are reporting that they are able to maintain reasonable occupancy, but have needed to start offering concessions, which were very uncommon in the market from 2005-late 2008.  Concessions range from waiving move-in fees to 1 month free rent (most common).

The downtown market; however, is expected to be impacted significantly more than the suburban markets due to the large amount of new supply in the market. Between January 2008 and December 2010, more than 3,000 apartment units will come on line in the downtown, or close-in east side markets. All of these units are elevator served and plan to serve the upper end of the market. However, due to the national recession, many of the potential tenants (22-30 year olds) have been hit hard by unemployment and can no longer afford to pay the rental rates that developers had planned in the $2.20 – $2.50/SF range. Absorption is in process at many of the projects with more developments to come on line in the next year. Stabilized complexes have already begun to lower rental rates dramatically and concessions are prevalent and typically include 1 month free rent and discounts, or free, garage parking. Vacancy has dramatically increased to near 8-10% in many of our recent surveys for stabilized properties. It is unclear where the downtown market rental and vacancy rates will end up, but due to the large new supply, everyone’s guess is that it will likely be below $2.00/SF and near 10% for multiple years.

Rental Rates

Similar to occupancy, rental rates are also declining in most submarkets. In suburban areas, managers are typically reporting rental rates $20 to $100/unit lower than a year ago. Managers at more luxury suburban complexes have seen the most significant decrease in rates as tenants are trying to reduce spending during the national recession and are opting to decrease rental payments when possible. Thus, where a luxury suburban complex was getting $900 – $1,000 for a 2BR/2BA unit in mid 2008, rents have typically decreased close to $100/unit and a concession of 1 month free may still be needed.

This rental rate decline is hitting the downtown market as previously discussed, but is also affecting some new suburban development. There are a few newer complexes around the suburban areas of the PMA that were originally planned as condominiums, but were converted to apartments due to the decline in the single family market. Many of these units are 1,400SF + townhouse units with attached garages, etc. The developers had expected rents close to $1.00/SF. However, the market is definitely experiencing a “rental cap”, where tenants are generally not willing to pay more than about $1,300-$1,400/unit, no matter the amenities or unit size in the suburban areas at larger apartment complexes. As these complexes lease-up, concessions of 2-3 months free have been seen, which decreases the overall economic rent. It will be interesting to see long term how these projects progress at a stabilized occupancy.

Investment Market Conditions

The current investment market conditions are very unstable in the PMA and greater Oregon area for multiple reasons: 1) decrease in investor demand for product 2) increase in capitalization rates 3) lack of available financing/ changes to underwriting requirements 4) investors who have capital are waiting on the sidelines in many cases for the market to bottom out. All of these market conditions tie together in one way or another and have led to a definite decrease in apartment values across the board. However, many sellers do not need to sell and have not been willing yet to capitulate to new market conditions

The biggest impact on property values has been from a significant increase in capitalization rates. Early in 2009, there was literally no good sales data to show what the increase was. However, recently, there have been a few sales of complexes (20+ units) that show cap rates generally 7.0+. To illustrate the dearth of sales in the first half of 2009, it is noted that in the first half of 2007, there were 60 sales of 20+ unit properties, 47 in 2008 and only 24 in 2009 according to CoStar. However, of the 24 sales, 5 of them were Section 8 properties that were purchased for LIHTC rehab and are not considered typical arms-length investment transactions. Thus, only about 19 sales have occurred during the first half of the year. Of the sales, only 2 have been 100 units or more and one of these sales was a 100 unit LIHTC property in Springfield. In regard to supply of properties for sale, LoopNet shows about 90 apartments for sale in Oregon of 20+ units as of early July. This number was about 30-50 typically during the height of the market in 2007 and early 2008.

In discussions with brokers, buyers are typically looking to purchase investment grade properties at 7.25 to 8.0% cap rates. The one closed sale of 100+ units in the PMA was in Tigard for a 1970s property and sold for a 7.6% OAR. This property would have likely been a 6.25 to 6.50% cap in 2007 or early 2008. Brokers report that most sellers are not interested in selling for 7.5% + and therefore, there is a large supply of apartments for sale on the market with little activity. Brokers have reported frustration with sellers who believe that conditions will “return to the way they were” with rates back in the 6 to 7% range. This is especially true with the less savvy sellers of smaller properties.

The reason why cap rates are unlikely to return to their historic lows is due to a significant change in underwriting loans, availability of financing, and increased risk pricing of real estate. When interest rates were 5.0-5.5% with an 80% loan to value rate with mezzanine financing available, investors saw little risk. Plus, at that time, underwriting was very lax, and often lenders used “proforma” rents, which expected 12 month rent growth. However, current underwriting and lending conditions are extremely different. First, there are very few lenders even willing to lend on apartments at this time. A few larger banks will lend at their own terms, and a few smaller banks may be willing to lend on small properties. However, for the main segment of the apartment market, the only current lenders are Fannie Mae or Freddie Mac. Thus, these two lenders are really driving the investment market. Currently, a 1.25 DCR is driving lending compared to a previous standard of 1.15 to 1.20. Current LTVs are 75% for refinances to 80% for acquisitions.

However, the most significant change in the process is the underwriting both by the lenders, but also by potential buyers. The lenders will only loan on current, in-place rents (sometimes lower if market rents are declining in the area), and expenses generally based on historicals. This expense standard has been significant because in the past, properties were typically sold using “proforma” expenses for some categories including R/M, turnover, on-site management, and admin. If the property had seen R/M expenses of $700/unit for the past two years, the market still expected to us a number of $400-$500/unit for a stabilized proforma. However, now, lenders are generally unwilling to do this and will place most emphasis on historical expenses. Thus, where proforma expenses would have been $3,200 for an apartment 2 years ago, expenses are now $3,600. This change in underwriting significantly lowers valuation.

When looking at investment grade deals, buyers are also being very conservative at this time due to declining market conditions. If current actual, average rents are $750, but current asking rents have declined to $700/unit, investors are typically using rents lower than the current average in their investment proformas, say $730/unit. Also, instead of the typical 5% vacancy, which was common to use in previous years, investors are projecting income in line with 6-10% vacancy/concessions/bad debt. Overall, these changes in estimating income reflect lower income levels than in 2008 as investors feel that market conditions will likely further decline before they get better. Investors are also basing their expenses on historicals, generally because this is how the loan will be underwritten by Freddie/Fannie, and the DCR depends on these estimates.

Even with the changes in financing, brokers and lenders report that there are still many buyers in the market. However, these buyers are only interested in buying properties that provide a good return, and thus, require cap rates in the 7.25+ range. One broker said that historically, a reasonable cap rate should be 100 basis points over a loan rate. With current market conditions being unstable, it is reasonable to assume that this 100 basis point, or higher estimate, is reasonable. Thus, if current rates at 6 to 6.25%, then cap rates should be 7.25% or higher for most properties. Overall, due to the lack of sales, the market seems to be supporting this theory.

Summary

Overall, apartment market conditions in the PMA are declining with lower rents, rising vacancy, and increased use of concessions. This will likely continue into the next 6-18 months, or until the economy regains strength and jobs are created and tenant spending confidence strengthens. Sales of apartments will also continue to be much lower than typical until owners either need to sell for financial reasons (upside down loan coming due, etc), or until owners realize that cap rates in the 5-6% range will not be seen again anytime soon due to the changes in financing, underwriting, and buyer expectations.

PGP Valuation has been serving the Portland Metro Area and Greater Oregon for the past 30 years. We have the largest real estate appraisal and consulting firm in Oregon and serve all property types including Industrial, Office, Retail, Apartment, and Land. Feel free to call the office to speak with an industry expert for any real estate consulting or appraisal needs.

Jeremy Snow, MAI is the Multi-Family team leader in the Portland office.  His team completes more investment grade apartment appraisals in Oregon than any firm.  Jeremy also has a specialty in restricted rent apartments (LIHTC, Section 8, and RD) and has completed these appraisals all over the State of Oregon.  Feel free to contact Jeremy for investment grade apartment questions or for your appraisal/consulting needs throughout the State of Oregon.

The impact of the recession and financial crisis on commercial real estate has been widely reported. With securitized lending out of the picture and banks less able to lend, purchase financing has been more difficult to obtain and available in smaller quantities. This has led to a slowdown in sale transactions for commercial real estate. To compare how convenience stores have fared, the chart below shows the trend in volume of transactions for west coast convenience stores and service stations as reported by CoStar Group Inc.

Sales volume reached their peak during late 2007 and early 2008 as a number of oil companies rapidly liquidated stores. By mid 2008, however, lenders had begun to pull back, and rapidly increasing fuel prices made operators’ margins difficult to predict. Property transactions fell precipitously, and at the height of the credit freeze sales were off more than 50% (3^rd quarter 2008 vs. same quarter 2007). Sales have rebounded slightly since then, but 2009 is still on pace to lag 2008 by 26%. During the period, many oil companies were in the process of liquidating portfolios of stores, which has not only cushioned the fall in transaction volume, but also contributed to the peak sales volume in 2007/2008. Additionally, CoStar Group Inc. has expanded its geographic coverage over time, so these figures may understate the decline in volume.

Although the majority of convenience store sales involve owner-operators, price trends have correlated strongly with the real estate investment markets. Just as capitalization rates peaked for many property types in 2006, data show median prices peaked for c-stores at roughly the same time. The chart shoes median and quartile prices for west coast c-stores and service stations.

Following rapid price appreciation of 31% in 2005 and 18% in 2006, median c-store prices have fallen for three straight years. Nevertheless, the fall has been muted, amounting to a decline of 16% since 2006.

Note that the lower quartile prices have held relatively steady while upper quartile prices have fallen the most. This is likely and indication that few owners of high-quality stores are willing to sell in a distressed market

In conclusion, data indicate that c-store values are falling. However, the decline appears to be less of a sudden correction than a gradual adjustment ongoing since 2006. Anecdotally, many owner-operators have found purchase financing difficult to find. Undoubtedly, this has hurt transaction volumes, but pricing has held up fairly well considering the pressure mounting on other sectors of retail.

Who among us has not been subject to greater and closer scrutiny, or has scrutinized others in greater depth in the recent climate of market distress? How do valuation experts report the meeting of the minds of the buyers and sellers when those players are on the sidelines?

The market downturn has been more widespread, more inclusive of the spectrum and breadth of property sectors than at most times in the past several low points in business cycles. The sickly symptoms in pricing and demand during the relatively recent past have been more like those afflicting limited-market properties in normal times. Scarcity hasn’t been an issue in the availability of most product types. Transferability and effective purchasing power have been curtailed by the constraints on the flow of credit. And the resulting muting of demand, has effectively stepped on the brakes in the marketplace slowing the velocity in transaction activity.

Is anybody in the market really out there, in the market? Are appraisers the voices in the wilderness calling out for somebody, anybody, to tell them what’s going on out there?

What are we searching for? In the good old days, as recent as twenty-four months ago, it was difficult for investors to make a mistake in any market. The pipeline was flowing with a slurry of cash and credit. Buyers were buying, Sellers were selling. Some sectors were doing “land office” business. Does anybody remember this? The market was speaking loud and clear about their views regarding a clear and exuberant relationship between income and value. Hindsight is calling into question the rationality of those perceptions, but it was what it was—and the relationships of income and prices were defined by the overall capitalization rates associated with the deals. The players’ expectations were committed by virtue of securitization, for better or worse and in sickness or in health.

Looking back with an eye toward the deals taking place during the recent exuberance, and even just using a low level magnifier, the relationship that buyers and lenders had entered into was more fragile than anyone would want to admit, then or now.

But now we’ve got a problem. Not the bubble; not the bursting of the bubble ….market analysts are lacking market-based information with which to fully understand the future benefits of ownership for investors. Investors are also void of access to the information, mostly because there isn’t much.

One option for appraisers would be to make predictions of proper capitalization rates based on most recent bona fide transactions, whatever can be found. We can always defer to our infallible judgment and breadth of experience…but each of these data resources is vulnerable for lacking true emulation of the meeting of the minds in the marketplace.

If only we could use interviews with buyers that would identify their view of required cap rates needed to close a deal were the solution to the quest, we could stop this discussion here. Everybody’s got an opinion. We can’t fabricate capitalization rates, can we?

I suggest we don’t, at least not without reasonable basis from the market’s perspective… lest we get caught when it matters. Most of you who are reading this likely think it always matters. Cap rates can be constructed from the matter that comprises the deal, particularly from the investor’s perspective, and for the benefit of the appraiser, tested for reasonableness.

One of the fundamental weaknesses in understanding and projecting cap rates in transitional markets is the need to look in the rear view mirror at past transactions in order to try to make educated guesses about the next transaction. This is not as much of a challenge if stability characterizes the forecasted climate. We’re talking about capitalization rate forensics because market instability is diminishing our traditional levels of predictability.

Forensics

So let’s get forensic. But before we do, let’s digress. What does “credible appraisal” mean? Most agree that somewhere in the process of the credible appraisal report presentation, the reader is led from premises to conclusions and they are able to walk away from their reading with a market-based perspective.

Appraisal academia typically starts the lesson plan imploring the student to test their conclusions for reasonableness. As elementary as this teaching is, the absence of reasonableness is on the Top 10 List of most frequently observed appraisal deficiencies. I liken the concept to sitting on the curb, across the street from the subject property, when all the research is conducted, and the analysis nearly complete, and asking whether the conclusion and its components are truly market-based.

Forensics is relevant here. Mostly because as observers of the market, without a good supply of transactions to study, we need to dissect our overall cap rate conclusions, and in litigation, the conclusions of others, to get a closer look at the quantity, quality, durability and risk associated with collecting lease income anticipated from the investment.

It is appropriate to remember that value is created for investment real estate most often by a combination of debt and equity. The deal has got to work in terms of providing sufficient return to both the debt and equity participants. Lenders appreciate this concept especially.

Investors are also aiming to first pay the lender and then have sufficient funds left over to justify handing over the cash to own the illiquid asset and its attendant risks that often require management expertise, at of course, some cost. So in the process of dissection of the rate, we need to understand that the cash-on-cash return, the equity dividend component, is the analogous measuring stick with which to compare the vehicles in the investment spectrum, which range on the low risk end, from the mattress; to the greatest risk, demanding the highest return, venture capital.

In the mattress, liquidity and management are not typical negative factors. There is however, risk of erosion of effective purchasing power. In the next level, the high safety/low return vehicles are the time deposits, money market and “passbook” savings accounts. Most classes of investment property lie somewhere below the stock market, and somewhere above theses traditionally safe, low return vehicles. So in the forensic analysis of the rate components, one target variable to evaluate is the available cash dividend, and its proper relationship with its competitive investment vehicles.

Investors will most always say that they’d sacrifice some cash-on-cash return for some upside property appreciation that also contributes to their total return.

As of late, the closer scrutiny of the overall rate is most typically undertaken by an appraiser who is facing a thinner supply of market transactions, and is in need of using anecdotal supplemental insights. The appraiser is more often applying a test of reasonableness via a Band of Investments analysis. Similarly in any adversarial proceeding it is typical for the “opposing” party to dissect the components of their adversary to check for reasonableness. Most decisions handed down in disputed valuation cases evaluate the reasonableness of the respective parties’ assertions.

Debt

The debt portion of the analysis is often pretty straight forward. This component of the overall rate consists of the return to the lender, and is calculated based on probable loan to value ratio, amortization schedule, and likely interest rate applicable to the loan. The mortgage constant is calculated, and the weighted return to the lender represents one of the overall rate’s components. Not all lenders are shut down. Their credit criteria, is however, likely requiring greater equity contribution and more stringent pay back terms. Far too few appraisers are consistently up to date with their knowledge of available loan terms.

Equity

The equity position is a little more challenging to know well, in that the equity dividend rate has historically been extracted from market transactions. If we had these, this discussion would be moot. So the next best thing, a proxy for the extracted dividend rate, relates directly back to the equity dividend rate desired or anticipated, as it compares to alternative riskier, or less risky, investment vehicles. These alternative vehicles need also be evaluated with regard to their degree of liquidity and management burden.

Dissection

Most of the readers of this discussion are likely looking for a practical way to employ this analysis to their advantage in an adversarial proceeding. You should be so lucky that you’ve narrowed the differences in value estimates with the assessing jurisdiction down to net income and overall rate. This may represent a fantasy dispute, because many debates appear to center on whether the sun rises in the east, or west.

Nevertheless, let’s work the equation backwards solving for one of the debt or equity variables, with the intent of testing the reasonableness through dissection of the assessing jurisdiction’s cap rate.

The first and most obvious (and typically most effective) test is to evaluate the reasonableness of the equity dividend rate assuming both parties have narrowed their dispute on anticipated NOI, by subtracting the debt component from the overall rate. By definition, the remainder component is the equity position. With an atypically low overall rate asserted by the assessing jurisdiction, the equity dividend rate will be atypically (and unacceptably) low relative to that needed to entice an investor into this particular real estate investment. This evaluation is conducted on a comparative basis comparing the assessment jurisdiction’s implied equity dividend rate, with less risky, more liquid, and non-management required alternative vehicles, e.g., the CD, Bonds, Money Market or Passbook Savings.

By employing a working forensic knowledge of the theoretical components of the overall rate, you can test and solve for reasonableness of both your asserted overall rate, and that of the opposing party.

As a side note, user beware of the possibility of skewing the OAR downward through manipulation of the NOI in the analysis of the few transactions that may be available, where reliable income data is not readily available from a knowledgeable source. This behavior is found within the category of appraiser-based data as opposed to market-based data.

For example, with recent market conditions, a spike in vacancy rates has been generally commonplace. Many data services track vacancy and report it to subscribers. More than a few times assessment jurisdictions have been observed substituting current actual market vacancy rates for anticipated stabilized rates applicable to the property in their imputed income pro forma. Out the other end comes an appraiser-based, artificially skewed, lower-than-market overall rate purportedly derived from a market transaction. This has been observed more frequently when fewer transactions have occurred and fewer details are available from parties to those transactions for analysis.

Practical Forensics

This sort of dissection doesn’t require any sort of advanced scientific approach. To mix metaphors, no rocket science is needed. The overall rate is a simple conversion rate that expresses the relationship between a market-based perspective of net operating income, and the price an investor would reasonably be expected to pay for the future benefits associated with owning that income. The components of the rate represent a multitude of assumptions, but are simplified into adequate returns, sufficient for both the debt and the equity positions. Through a thorough understanding of the rate components and the reasonableness and market-based support for the components as they interact to form the overall capitalization rate, we have a better understanding of capitalization rates even without a prolific amount of market activity.

Now, it’s time to sit on the curb, and ponder the reasonableness of the rate.

TODD S. LIEBOW, MAI, is a commercial and industrial real estate appraiser and an Executive Shareholder in the firm of PGP Valuation Inc located in Portland, Oregon. Mr. Liebow’s professional appraisal experience includes five years as a commercial and industrial appraiser for the Clackamas County Assessor’s Office, in Oregon City, Oregon. Since 1983, Mr. Liebow has been in private practice with PGP Valuation Inc, specializing in valuation analysis for ad valorem tax assessment appeals and other forms of litigation. Mr. Liebow is a designated member of the Appraisal Institute and is a past president of the Greater Oregon Chapter of the Appraisal Institute and the Oregon/Southwest Washington Chapter of the International Association of Assessing Officers. He has chaired the Portland Building Owners and Managers’ (BOMA) taxation and legislation committee and has been a member of the Associated Oregon Industries’ committee on property taxation. Mr. Liebow is also a member of the Institute for Professionals in Taxation and was the Chair of IPT’s 1997 Property Tax Symposium as well as the Overall Chair of the 1999 Annual Conference. He has served as a member of both the IPT Annual Conference and the Property Tax Symposium committees several times over the past 15 years. Mr. Liebow has authored several articles on the ad valorem assessment system and has lectured frequently on tax and valuation issues. Mr. Liebow is a founding shareholder of Lewis and Clark Bank, a community bank in Oregon City, Oregon. He serves on their Board of Directors and is a member of their Loan and Corporate Governance Committees. In recent years, he has addressed Appraisal Institute Seminars on “Valuation of Environmentally Impaired Properties” and the American Bar Association/Institute for Professionals in Taxation’s Advanced Property Tax Seminars on “How to Create an Effective Appeal Team”, “Common Errors in the Appraisal Process,” “Selection and Evaluation of Attorneys,” “Hot Topics in Appraisals,” and “Valuation of Commercial and Industrial Property — Beyond the Cost Approach.” He is a graduate of Lewis and Clark College, with a BA in Philosophy with Honors, 1978.

The last couple of years have represented a time in which markets stagnated, not solely due to the lack of available capital, but also due to the gap in expectations between buyers and sellers.  Sellers clung to memories of historically low capitalization rates and aggressive rent projections, while buyers assumed the worst in their cash flow analysis and disregarded cap rates altogether.  The chasm between buyer and seller over the last couple of years has been wide, to the point of stunting almost all activity in the market.  The result of the stagnation is that market values are relatively vague across most property types.

Most industry experts concur – the commercial real estate market trails residential and is affected by all the additional market conditions in play. When combined with the still-compounding effects of stock market fluctuations, increasing unemployment, decreased consumer spending (related impacts to retail sales and more), and ongoing corporate restructuring and downsizing to adjust to the greater cycle, conditions are likely to worsen in the short- to medium-term. Key markets such as New York are just beginning to feel the impacts of financial sector lay-offs with commercial space inventories dramatically increasing and residential foreclosures accelerating. These key markets set trends across other areas of the nation.

In addition, as financial institutions continue to flounder or be seized by the FDIC, related asset workouts are the growing trends. In the past, the FDIC would typically take over one bank in a time span covering years. In 2009, as reported on CBS’s 60 Minutes, the FDIC has seized over 50 banks to date and the number is growing. Sitting on the books of these failed financial institutions are portfolios of properties that must be immediately appraised for true, current value and factored against the market conditions in order to get them sold. A related increase of property sales to liquidate these assets, both previously foreclosed properties and those in active loan management, will have direct, negative impacts on the market through further increases in inventories and the liquidation of assets at drastically reduced prices to facilitate rapid disposition and cash flow.

With all of these factors in play, expect market participants in the future to be more realistic in their internal underwriting, but to place emphasis on initial cash-on-cash returns and a flight to quality.  Well-located and tenanted product will slowly begin to move again as the expectations between buyers and sellers move toward each other. However, the flight to quality will benefit the some markets sooner than other areas of the U.S.

PHOENIX, AZ – PGP Valuation, Inc. (PGP), the industry-leading real estate appraisal firm with offices worldwide, has announced that Phil Steffen, MAI, has been named executive managing director of the firm’s new office opening in Phoenix, AZ. Steffen is a recognized member of the valuation community and 30 year veteran of PGP. He will now be focused on developing valuation services for the Arizona markets as the growing team supports client relationships across the multi-family, industrial, retail, office, land and residential development markets.

“Phil’s exemplary knowledge of the industry and proven track record for delivering superior results will truly benefit our growing client base in this vital market,” said Ken Harrison, MAI, president and CEO of PGP. “As we have continued to expand the business in recent years, Phil has been instrumental in helping us tackle many leading initiatives within our firm. Knowing that his skills will now be fully channeled to the delivery of differentiated appraisal services in Arizona leaves us with the utmost confidence in building the best appraisal team possible.”

Steffen joined PGP in 1979 and helped establish PGP’s initial presence in the Portland, OR market. In 1984, he moved the Puget Sound region and developed PGP’s Seattle office into a successful 25-person, full service appraisal operation.

“PGP has always been committed to developing effective teams of appraisal specialists with thoughtful expansion of offices in markets where our client base can truly leverage our unique service offerings,” said Steffen. “Phoenix represents an outstanding opportunity for us to develop a strong team with a focus on specific property types. I am fully committed to the development of this vital new office and look forward to forging strong relationships within the greater Arizona real estate community.”

The Phoenix office is being developed in conjunction with team members Matt Steffen and Alex Esnard, both of whom transferred to Phoenix from PGP’s San Diego office. Current plans call for immediate expansion of the office which will be further staffed with valuation specialists covering the full spectrum of appraisal needs on a state-wide basis and leveraging PGP’s extensive national and international client networks.

Founded in 1978, PGP Valuation Inc. is the world’s largest valuation services firm and a member of the Collier’s International real estate family of companies, a First Service CRE organization. PGP and its affiliates maintain offices in over 25 major North American markets and expanded coverage in over 88 international markets. The company offers differentiated property valuation services through proprietary data, technology, analysis and delivery methods. Its depth of experience, as well as many highly specialized areas of practice, is the result of over 1000+ valuation experts providing unparalleled quality and service across 45 countries. www.pgpinc.com

Contact: Joe Fitzpatrick · 213.399.4999 · joe.fitzpatrick@pgpinc.com

CARLSBAD, Calif. – PGP Valuation Inc., the industry-leading appraisal services firm with offices worldwide, has announced that Lance W. Doré, MAI, FRICS, has been appointed to the newly created position of Vice President, Client Services. In his new corporate role, Doré will be responsible for the firm’s major client relationships benefiting from the company’s national and international service delivery platforms. Further, he will oversee personnel and quality standards associated with the delivery of valuation services to these clients.

“Lance is one of the most recognized and respected valuation industry experts of our time,” said Ken Harrison, CEO & President of PGP Valuation Inc. “His depth of knowledge – across a whole spectrum of property profiles and geographies – has a long history of generating powerful results. Now, Lance will carry his mastery across our organization for the benefit of PGP clients seeking truly integrated services across broad geographies.”

“I am extremely pleased to have the opportunity to expand PGP’s practice expertise while providing even greater levels of service to our growing and diverse range of corporate, institutional and government clients,“ said Doré. “We are uniquely suited to serve the needs of portfolio-driven clients in these especially challenging times. Our insights and specialized services are already proving themselves to be of genuine and increasing value.”

Doré, a 26 year industry veteran, holds geographic expertise across the United States as well as Asia, Central America, Mexico and Europe while supporting a range of clients and property types. His work has included the valuation of energy related properties, special purpose lands and facilities, as well as a wide variety of office, retail, industrial, and multi-family projects. He is an adjunct professor at the Russian Finance Academy and has been a guest speaker and instructor at the Pan Pacific Conference on Valuation, for the Government of Cyprus, for the Russian Federation on the Valuation of Oil and Gas and Power Plants, for the Royal Institute of Charter Surveyors on the Government and Regulatory Risk for Real Estate, and for Pepperdine University, Graziadio School of Business and Management.

Founded in 1978, PGP Valuation Inc. is the world’s largest valuation services firm and a member of the Collier’s International real estate family of companies, a First Service CRE organization. PGP and its affiliates maintain offices in over 25 major North American markets with expanded coverage in over 88 International markets. The company offers differentiated property valuation services through proprietary data, technology, analysis and delivery methods. Its depth of experience, as well as many highly specialized areas of practice, is the result of over 1200+ valuation experts providing unparalleled quality and service on a worldwide basis.

Contacts

PGP Valuation Inc.
Joe Fitzpatrick, 213-399-4999
joe.fitzpatrick@pgpinc.com

Read more of what Bloomberg had to say here

Finding The Bottom Vs. Finding Value
by Jackson Cooper, SIOR, CCIM – Managing Director
Sperry Van Ness – Boise, ID

Arriving at a decision on the best strategy for how to successfully navigate the commercial real estate market during these challenging economic times is vexing to many an investor. Do I, or don’t I??? That is the conundrum facing most commercial real estate investors in today’s market. Do I, or don’t I liquidate my portfolio (or at least my non-performing assets)? Do I, or don’t I stand on the sidelines and wait-out these turbulent times? Do I, or don’t’ I get aggressive and take advantage of the decline in property values and the spike in acquisition cap rates? In the text that follows I’ll put forth counsel based not upon the emotions of the times, but rather the forthcoming advice is based upon my years of experience in successfully advising clients in both advancing and declining commercial real estate markets.

It is often said that you can only count on two things in life: death and taxes. There is a third thing that is often overlooked…market volatility. Whether markets are moving up or down isn’t really the issue. The issue is whether or not value can be added or created in the investment being considered. What tends to happen to the non-sophisticated commercial real estate investor is that they rely on upward moving markets to create value for them. If the market happens to move in your favor that is a plus, but it should not be the sole basis upon which your investment decision is made. You need to be able to add value to an asset through operational improvements, repositioning, restructuring, recapitalizing, re-tenanting, or other proactive strategic or tactical value enhancements. This is the mark of a savvy investor.

It doesn’t really matter whether you’re looking at the equity market, commodities market, bond market, the commercial real estate market, or any other investment market, as all investment markets have certain similarities…It is my hope that the following five points will be useful in refining your investment philosophy moving forward:

1.Market Timing: Let me be very blunt right from the outset…not only is it an exercise in frivolity to try and time a market bottom, but many significant investment opportunities will simply pass you by as you stand on the sidelines waiting for that almighty market bottom to occur. I know…smart investors buy low and sell high right? Sure, but there is a difference between recognizing value and opportunity that lead to superior investment returns, and trying to wait for that ethereal moment in time that represents the exact bottom of a market. Put simply, one in a million will correctly time a market bottom, while many investors will generate significant returns by exploiting the opportunities that a declining market provides.

2.Professional vs. Amateur Investors: Tough times tend to separate the wheat from the chaff. The challenge facing most commercial real estate investors today is to become honest with themselves in determining whether they are in fact astute commercial real estate professionals, or whether they were among the masses just riding a wave while it lasted. You see professional investors are always in the market…during good times and bad. They understand that more “lasting wealth” is created in declining markets than in overheated advancing markets. You see it’s the non-professional investor (stupid money) that is both late to the market, and then overstays their welcome by holding on too long. In point number 1 above I mentioned top of the market…Whenever you reach a point in the market where everyone (even your cab driver) is a “real estate investor” you know you’ve found the top of the market.

3.Invest in Opportunities not Asset Classes: The most successful investors are fluid in their approach…they see changes in the market as being synonymous with the creation of new opportunities. While I certainly understand the synergies that come from developing a niche focus, I don’t believe they can make-up for the increase in diversification and scale that comes by exploiting opportunities across asset classes. Are you a retail investor, or a commercial real estate investor? Are you a multifamily investor or a commercial real estate investor? You see it is my belief that the core of sound commercial real estate investing is present across asset classes. The same characteristics that make an investment attractive in one asset class are ostensibly the same in others. Location, current market dynamics, tenant mix and quality, entitlement and construction risk, absorption and vacancy (supply and demand), age and construction quality, micro and macro economics, NOI and valuation drivers, etc. are relevant regardless of whether you’re investing in industrial or office assets. Furthermore, it’s important to be flexible in the structuring of your investment opportunities. As an example as long as the risk/reward ration falls within your investment guidelines it shouldn’t matter whether you are a principal in entirety, have a limited ownership interest, where you investment falls in the capital structure or any number of other considerations. You either like the opportunity or you don’t…the rest of the issues are just details to be worked out at the negotiating table.

4.Understanding Opportunity: Rarely will you come across a static opportunity in the sense that it will stand idle and wait for you to act…Significant opportunities are not only scarce, but they typically operate on the principal of diminishing returns. The longer you wait to seize the opportunity the smaller the return typically is. In fact, more likely is the case that the opportunity will completely evaporate if you wait too long to seize it. Keep this thought in mind; when opportunity knocks…answer the door. I can’t even begin to count the number of times I watched people miss great opportunities due to a poor sense of timing. Not too surprisingly, people who possess a poor sense of timing usually don’t even understand timing is an issue. How many times have you witnessed someone holding-out for a higher price, better valuation, evolving markets, technology advances, or any number of other circumstances that either never transpires, or by the time they do, the opportunistic advantage had disappeared? I’ve observed the risk adverse take due diligence one step too far, the greedy negotiate too long, the impulsive jump the gun, and the plodders move to slow. As the saying goes “timing is everything.” The proverbial window closes on every opportunity at some point in time. As you approach each day I would challenge you to consistently evaluate the landscape and seize the opportunities that come your way. Better to be the one who catches the fish than the one who tells the story of the big one who got away…

5.Seeking Sound Counsel: The smartest commercial real estate investors surround themselves with professional advisors who extend their strengths, shore up their weakness, improve their access to market knowledge, and provide more visibility and broader access to investment opportunities. What really separates the successful investor from the average investor is that the successful investor has a broader sphere of influence and a larger network helping them to be successful than the novice investor. If you ever wonder why certain investors seem to get access to the best deals, it is usually because the professional investor simply enlists more resources working on their behalf.

My advice is this…don’t let the current market conditions intimidate you. Rather create an opportunistic approach to commercial real estate investment that will simply adapt your investment guidelines to the current market dynamics. There is every reason to get into the market and take advantage of once in a generation opportunities that exist now.

About the Author

Jackson Cooper, SIOR, CCIM is the Managing Director for Sperry Van Ness in Boise. He has served as a Senior Advisor for Sperry Van Ness for 5 years specializing in office, industrial, multifamily, hospitality, retail and land for development property transactions. With over 30 years of commercial real estate experience, his knowledge is leveraged through the innovative concepts of Sperry Van Ness. Prior to relocating to Boise, Idaho Jackson was the first Sperry Van Ness affiliate in Oregon and was honored in the Wall Street Journal as one of Sperry Van Ness’ top Advisors in 2004 & 2005.

To date Jackson has closed over 1 Billion dollars in sales transactions. Jackson is extremely active in the commercial real estate industry, holding the designations of Certified Commercial Investment Member and Society of Industrial and Office Realtors. He is a member of the National Association of REALTORS, Ada County Associations of REALTORS, Boise Metro Chamber of Commerce and Boise Chapter of BOMA. Jackson Graduated from Washington State University with a Bachelor of Arts Degree in 1970. Jackson is currently licensed in Idaho and Oregon. Through Jackson’s experience over the last 30 years he has gained local, regional and national expertise of market knowledge & trends. Along with the national platform of resources that Sperry Van Ness provides, Jackson can present each client with up-to-date analysis and state-of-the-art marketing concepts to maximize their investments.

For more information you can reach Jackson at any of the contact points listed below:
Email: cooperj@svn.com
Phone: 203.363.7000
Web: www.jacksoncooper.com
Copyright © 2009–Jackson Cooper
This Office Independently Owned and Operated
All information presented by Sperry Van Ness (SVN) has been obtained from sources deemed reliable.
SVN makes no representation with regard to the accuracy of the information contained herein.

The day of reckoning has long passed its arrival industry wide; the time to take charge of our future is now. Our challenge is three fold: how do we forget everything we have learned; yet, exploit all of the skills we have accumulated from years of experience; and, give up our mental memory of the future? We as real estate practitioners need to take charge, we need to build, we need to buy, we need to invest; so, we need to ask ourselves: What will it take to get back into the game? How we will stay relevant until that time for each of us arrives?

Real estate as an asset class always was a worthwhile investment for three reasons: we were led to believe that it was a hedge against inflation; it was an asset that you could buy with leverage; and, that the combination of safe leverage and rental increases were in some way driven by the existence of job growth across our economy.  In Q1 2009 the economy lost 1.9 million jobs and unemployment currently sits at 8.5%. Since 1939, our job growth over any 120 consecutive reporting months-a decade-has always been in excess of 12%. In January of 2010, we will acknowledge our own “lost decade” as there will be no effective job growth between January 2000 and January 2010. During the same time, we have added 13%-14% new office stock across the U.S. market place. This is clearly not good for the asset class.

Economists believe that unemployment will crest by the end of 2010. If history repeats itself, in 1986 and 1987 we had a valuation peak followed by financial crisis, followed by a political solution to the economic collapse. It wasn’t until 1994-eight years later-that the marketplace truly settled and began to grow. During 2006 and 2007 we had a valuation peak followed by extraordinary financial collapse and a political solution to this economic strife. If history repeats itself, we’re not back to a stabilized marketplace until 2014.

Accelerating or retarding the speed of recovery is the reality of a synchronized global recession. We have complications associated with a forecast of job loss or valuation loss due to the world’s increasingly interwoven economies and financial systems. As globalization speeds the flow of economic benefits in good times, in times of contraction, globalization transmits trouble with enormous speed and force affecting economies all over the world. Our economy shrank at a 6.3% pace at the end of 2008 which was the worst showing in more than a quarter of a century.

Unemployment rises, home values fall, and investment portfolios shrink so consumers cut back forcing companies to slash production and jobs. The U.S. consumer is 70% of U.S. GDP; the U.S. represents about 1/3 of the world’s GDP; therefore, the U.S. consumer is 20% of the world’s GDP. At the same time, we face growing protectionism sentiments across the globe verses our collective need to stay synchronized globally to get out of this recession. How do we get through the global recession that sees a great decrease in demand for all products let alone real estate space? When we emerge from recession to recovery, how do we have a sustainable path that makes good business decisions not just for one year, but for many years to come? If real estate is a “location” business, where is your business positioned to exploit the opportunities that 2009 and 2010 will bring forth?

A long period of healthy economic growth convinces people to take bigger and bigger risks. In the fall of 2008 former Chairman Greenspan insisted that the precipitating factor of the 2008 crisis was the failure to properly price risky assets. As you consider your play in this real estate cycle, consider your capacity to evaluate, analyze, identify, assess and price risk. You must consider the partners who have provided equity capital to your individual business plans as well. Without goal congruence as it relates to evaluation, analysis, identification, assessment and ultimate price of risk, the proverbial rug is likely to get pulled out from under your business plan. It’s bad enough that we stand on shifting sands vis-à-vis the regulatory ground rules that our government seems to be placing upon us. As we stabilize housing, fix the banking system, get credit flowing and re-regulate the financial markets-remember that hope and fear are inseparable. We need to ensure that those who provide the equity for America’s deleveraging are in sync with the real estate owners and operators as to how they identify, assess and price risk. We believe that investors like risk (volatility of outcome) so long as they can price it; but, what investors hate is uncertainty-not knowing how big a risk is. Markets buy and sell risk that is wanted and unwanted.

Real estate is about risk shift and the market place is where this shift (for price) takes place. Today however, capital “markets” seem to be an oxymoron. We don’t see capital flows returning to the levels we experienced in 2007. The combination of devaluation of assets, lower loan-to-value (LTVs) and decreasing velocity of transactional turnover should cover all but about $50-$70 billion of the capital needs of our industry. We don’t see securitized mortgage lending returning until there is stability in the interpretation of mark-to-market valuation as well as sale treatment by the accountants on the balance sheets of our financial institutions. Pricing of course will be critical for the “new securitized world” given the volatility (risk that must be priced) heretofore bond buyers have experienced since June of 2007. 

Today, the market doesn’t know what to expect. There is regulation uncertainty and there is a fear that regulation will change, leaving us regulation by deal. Can and will the government change the rules on the business community whimsically?

Money supply’s effectiveness depends on how quickly people spend it-that is called velocity. If people horde cash, velocity falls and more money is required to keep the economy moving. As velocity continues to fall faster than the Fed can pump up the money supply, our government must spend on goods and services. Yet Congress does not have its own stash. Every dollar it injects into our economy is taxed or borrowed out of the economy. Our economy has stalled, with insufficient aggregate demand, with a decline in demand for goods and services, sales fall. Production is cut, people are laid-off, unemployment rises and declining profits further depress demand creating a vicious circle. We have to increase demand through consumption, investment, net exports and government purchases. Cheap credit, the usual route to recovery has failed to work. Lenders have pulled back; borrowers are focused more on paying down debt and building up savings. Keynesian economists advocate increasing government spending to combat economic downturns and generate jobs.  

Motivations matter. Banks, whether they are local, regional or national interpret “troubled assets” and the use of TARP or PPIP money differently. “Toxic” to a local bank may be acquisition, development and construction loans for home builders while “toxic” for the largest banks in the globe may be mortgage securities. The motivations of banks differ from life companies (regulated by 50 different state regulators) which are different than the motivations of a securitized lender (and whether we are dealing with a trustee, a master, a primary, a sub, or a special servicer). In this market place knowledge matters, motivation matters, relationships matter.

Our future gets clearer every day. If our crisis was caused by a dramatic under pricing of risk, resulting from a combination of endless supply of capital and an insatiable appetite for leverage; then, our future is one of lower leverage, greater transparency, greater regulation and an organized marketplace where transactions are done responsibly. Regulation has the tendency to create accounting rules and capital requirements that aggravate financial retrenchment during a slowdown and financial access in a boom.

All real estate makes money; the only question is who owns it at the time.

Ariticle written by Jack M. Cohen, CRI, CMB, Chief Executive Officer of Cohen Financial

Download PDF article here

The dislocation in the commercial real estate capital markets that exists today in the second quarter of 2009 has frustrated users of capital and left them feeling hopeless. The small universe of debt and equity providers that are willing and able to provide capital today want to advance less loan dollars on your deal while also taking on less risk. Most of the time that means that it’s a deal you cannot make.  Thankfully, after successive quarters of bad news, most of us are past the denial stage and are making attempts to exist in a broken market.  The leverage being offered by capital providers today would make sense if cap rates were closer to double digits, but unless and until that market correction happens, there will be further frustrations as both borrowers and lenders are fighting to preserve their equity and maintain returns seen earlier in the decade.  The following are some survival tips that could help your deal:

1.    Focus on the borrower/sponsor.  If you haven’t already, organize all personal financial information into a well presented document that clearly lists all assets & liabilities as well as a schedule of real estate owned that includes mortgage data. Also include a resume with past projects that demonstrate you have the appropriate experience necessary to perform on the subject business plan. Borrower’s are being scrutinized much more today than during the last boom. Give the lender every reason to promote your deal up the food chain.

2.    Focus on operations. If vacancy is up in your submarket, make sure you have a documented plan for tenant retention & expense management. Include your managers and leasing brokers on every aspect of the plan that is appropriate.  A solid business plan will illustrate to a potential lender that you have your head in the game and make you someone they want to lend to.

3.    Reduce risk wherever possible. A development deal may need to move forward because of a pending land loan maturity.  Attracting a development loan will be difficult, but may be possible if you reduce risk by attempting to presale your development, in whole or in part, to a serious buyer who is willing to make a sizeable earnest money deposit. This could add a credit enhancement to your deal by showing the lender they have an exit with some teeth in it.

4.    Consider smaller investments (loans < $5 Million). The majority of debt providers who are in the market right now are making loans under this amount, thus increasing your chances.

5.    Partner up. A new equity partner, whether a local operator, a high net worth individual, or an institution, can provide additional loan guarantees on a new loan and could infuse cash into a lagging project that is facing a loan maturity. You dilute your ownership position, but you could save your investment and you may find a partner who will complement your weaknesses in areas such as cash, operations, local expertise, etc. 

6.    Adjust expectations for returns. The 55-60% loan to values we live with now vs. the 80%+ values we saw often during the last boom are requiring investors to use more of their cash to get into investments which puts downward pressure on leveraged returns. 

7.    Hire reputable CRE finance professionals. Ask around and commit to hiring a mortgage broker who you trust or comes recommended by someone you trust. It’s essential to exclusively engage a mortgage broker early in the process that will be accountable to you and the transaction. A mortgage banker plays a dual role by uncovering investments for the lender while sourcing the appropriate solution for the borrower. Look for brokers who receive their compensation from the borrower and not the lender.  It’s important to the deals success to have one professional as the single point of contact who is your advocate in the capital markets, much like you would have one listing agent. 

8.    Explore underlying loan assumptions & seller financing.  According to Real Capital Analytics April Issue of Capital Trends, more than 50% of deals being done right are being capitalized with assumable debt and/or seller financing.  This can be a good source of capital for someone who must transact because of a 1031 exchange deadline.

The biggest news in the retail market has been the filling of chapter 11 of General Growth Properties (GGP). According to GGP’s Quarterly 8-K, they own more than 167.7 billion SF of retail space. NOI for the first quarter of 2009 for GGP was $608.6 million, a decrease of approximately 4.1% from the $634.5 million reported in the first quarter of 2008. Overall occupancy for all of GGP’s properties is at 90.9% compared to 92.7% from a year ago. 167 retail properties, including some of the largest malls in the nation, are involved in the recent bankruptcy filling. Some of the local retail properties involved in the bankruptcy proceedings include: Division Crossing (101,000 SF) in Gresham and Pioneer Place (370,000 SF) in downtown Portland.

Jeffrey R. Shouse joined PGP Valuation Inc in January 1998. He is working toward receiving his MAI designation. His primary focus is on the valuation of mobile home parks, self-storage facilities, and multi-family developments. Over the last several years, Jeff has appraised these property types in over 40 states.His clients include lenders, developers, owners, attorneys, insurance companies, and redevelopment groups.

Jeff was raised in Sacramento, California. After high school graduation, he attended Utah Valley State College where he received an Associate Degree. He then attended Brigham Young University and California State University, Sacramento, receiving a Bachelor Degree. Jeff is currently the Senior Managing Director for the Sacramento, San Francisco, Irvine, and Denver offices. He oversees the largest team at PGP Valuation with 17 total employees.

Jeff’s responsibility within the firm is to oversee the Business Development Group. Jeff enjoys sports and his family is a high priority in his life (married – four kids). He currently serves as a Community Affairs Director for his church. He has traveled extensively throughout Europe and speaks Estonian.

More Info Here

A lot of investors steered clear of this passive investment due to the lack of rent growth, the above market rents associated with these built-to-suit projects and the low going in cap rates. Additionally, the values for this asset class are directly impacted by cap rate trends; there is no opportunity to offset increasing cap rates with rent growth because the contract rent is typically flat anywhere from 60 to 75 years. An investor that purchased a Walgreens at a 5.75% cap rate should know that there is a good chance the property has declined in value in excess of 20% (assuming 7% & up cap rates).

The following analysis is a basic overview of how our company recently estimated the applicable cap rate for a Walgreens property in eastern Oregon.

Analysis

As will be discussed shortly in the National Investor Survey, capitalization rate have jumped recently. This is notably true for asking rates of Walgreens. The Seattle-based senior vice president of CB Richard Ellis’ net-leased group, Jeffery Thomas, was recently reported in February 2009 as saying that because debt markets have become increasingly unstable since the fall of 2007, there has been a significant increase in the number of Walgreens marketed at above 7%. He feels that the ones currently marketed below 7% are stagnating and will soon be re-priced at more realistic levels. This is noted in the following Current Listings Cap Rate Summation Table, where Comparable 6 was just recently re-marketed at a 7% capitalization rate, up from 6.75 in March, 2009. Finally, Jeffery Thomas was quoted as saying that “We fully expect to see the Walgreens’ average asking cap rate reach 8% at some point in 2009.”

The following table summarizes six current listings of Walgreens along the West Coast, with the majority of them located in the Pacific Northwest.

All three of the listings in Oregon have listing capitalization rates ranging from 7.2% to 7.5%. The one Idaho listing is being offered at a capitalization rate of 7.3%. The lowest capitalization rate (7%) is for the California listing, and it is noted that it was being offered at a 6.75% capitalization rate as recently as the end of March 2009. Noting that these are listings in a buyers market, they are likely slightly low to good indicators for the subject.

The following table presents the capitalization rate conclusion by the market extraction method.

Band of Investments Technique – Because most properties are purchased with debt and equity capital, the overall capitalization rate must satisfy the market return requirements of both investment positions. Lenders must anticipate receiving a competitive interest rate commensurate with the perceived risk of the investment or they will not make funds available. Lenders also require that the principal amount of the loan be repaid through period amortization payments. Similarly, equity investors must anticipate receiving a competitive equity cash return commensurate with the perceived risk or they will invest their funds elsewhere.

 To analyze the capitalization rate from a financial position, the Band of Investments Technique is used. Available financing information from lenders and the sales comparables indicates the following terms:

Equity dividend rates vary depending upon motivations of buyers and financing terms. Although investors have been accepting meager equity dividends in recent years as low as 4% for this property type, moving forward opportunistic buyers will be most active and will require higher cash-on-cash returns. This factor is somewhat tempered by the low returns being provided by alternative investment vehicles (stock market, bonds, etc). The previous terms and an appropriate equity dividend rate are used in the Band of Investments calculations, which are presented in the following chart.

National Survey – The investor pool for the subject property includes national, regional and local investors. While all three groups place emphasis on local cap rates, regional and national investors would also strongly consider national cap rate trends due to the potential to invest in other regions that are offering higher rates of return. The following table summarizes national cap rate trends for net-leased properties.  

The preceding table clearly shows that cap rates slowly trended upwards through the end of 2007 and the first three quarters of 2008. The rate of increase sharply escalated in the fourth quarter of 2008 when it increased by 20 basis points. The increase in the most recent quarter was even more pronounced when it jumped by 73 basis points. The year to year increase was nearly a full percentage point at 95 basis points.

Retail properties in the Oregon marketplace have consistently been trading at slightly lower effective cap rates compared to the national averages. The region’s resilience to the changing national real estate market is commendable; however, the sweeping change in the mindset of investors has caught up here as well. Due to the substantially reduced transaction volume (down as much as 75% in 2008), it is rather unclear when the inflection point occurred; nonetheless, local cap rates have bottomed out and are on the rise. Pinpointing the applicable cap rate for the subject using national survey data is somewhat subjective. The most reasonable cap rate that can be derived from this analysis is presented in the following table. 

Capitalization Rate Conclusion – For investments of the subject’s general size and price, and when sales activity is brisk with relative market stability, the Market Extraction Method is most often relied upon by buyers and sellers to develop cap rate decisions. However, recent events indicate rapid and profound shifts in the financial environment and the economy on local, national and global levels. The other two approaches developed have varying limitations, but generally support the upward shift in capitalization rates. Taking all these factors into consideration, the following table summarizes the various capitalization rate indicators and provides the final capitalization rate conclusion.

Up to this point, a majority of the articles posted were written by us (the creators) or by other colleagues that work for PGP, Valuation Inc. We recently have offered opportunities to outside market participants to post industry articles and various market reports. We would like to extend the same invitation to all of our readers. If you have something intelligent to share about commercial real estate, we want to post it. If your company provides free market data such as quarterly market reports, market overviews, economic forecasts, industry presentation notes, etc, please send them our way. Anywhere in the world. If you have a blog or web page with similar information, you should be on our blogroll. You can email us by clicking on the Contact link on the Home Page.

The blog has been running for approximately three months. We started by posting a handful of local and regional retail articles, and wrote and posted more articles as time permitted. Over the past couple weeks the blog topics were expanded to include various other market sectors and real estate topics of interest. To date, the site has achieved 1,658 unique visitors with close to 20,000 page views. Users are primarily from across the nation (46 of 50 states), but also include 26 nations/territories. We are very excited with our current penetration given that the blog was only advertised at a local (Portland, OR) level.

We will not allow direct marketing on this site; however, we will permit a small amount of passive marketing (example below) with each article and market report. However, we will explore offering a small amount of banner add space to companies that contribute the most information to the site. Additionally, we have no intention of posting articles with views that are contradictory with the core values of our company.

In the spirit of promoting transparency in the commercial real estate industry to everyone that takes interest, access to this blog/web page will always be free of charge. We fully understand that our competitors will have access to useful data that we gathered, analyzed and reported; this will promote more credible appraisal reports, which will benefit the appraisal industry by increasing public trust in our services.

“The preservation of the means of knowledge among the lowest ranks is of more importance to the public than all the property of the rich men in the country.”

-John Adams

Share your wealth of knowledge.

PGP in 154 Words:

PGP Valuation Inc was established in 1978 and is now one of the largest and most successful appraisal firms in the world, with over 30 members of the Appraisal Institute (MAI) and 150 professional appraisers on staff in the United States and Canada in 17 office locations from Boston to Portland. In November 2006, FirstService Corporation acquired a controlling interest in PGP. FirstService is the parent company of Colliers International (CMN), one of the largest and most respected real estate services companies in the world. FirstService also acquired a controlling interest in MHCM Project Management, Cohen Financial, and PKF Consulting. The result of this alliance is a powerhouse of comprehensive client services; including appraisal and consulting, commercial brokerage and management, and lending. PGP was recently contracted as the Quality Control and Consulting firm for all real estate related issues for the FDIC, which speaks volumes to the care and commitment we have for value.

PGP Valuation and Colliers International have been able to keep pace with the changing market. Through our national platform of real estate appraisers and brokers, we are able bridge the gap between historical data and emerging trends.

There is uncertainty in the market from all sides. Buyers, sellers, owners, borrowers, lenders, brokers and appraisers continue to look at current and past events to project how the real estate markets will react in 2009. Below is summary of key factors that will impact the valuation of real estate in 2009:

Transaction Volume

There are simply fewer deals being done in the market at this time. Sales volume is off 50% to 75% in the major commercial brokerage companies. According to Real Capital Analytic’s quarter in review (Oct. 2008) sales volume is down 54% in term of total dollars and 50% in number of transactions between 2007 and 2008. However, much of this volume occurred in the first half of 2008 and year end number are anticipated to be further off – a trend that will likely continue into the first quarter of 2009. With fewer investment grade industrial properties on the market and limited recent sales to track value trends, market participants are uncertain in relation to key statistics such as capitalization rates and discount rates.

Financial Markets

There continues to be turmoil in the financial markets. Despite the recent government bailout program there is a lack of liquidity in the market. This makes financing large, institutional assets more difficult and resulted in as much as 50% of deals being done in market including assumed debt.

Leverage has changed dramatically. Highly leveraged deals with low interest rates and abundant capital fueled capitalization rate compression through 2007. With many lenders on the sidelines, lower LTV’s, and higher interest equity yields will play a larger part in pricing.

Impact on Capitalization Rates

There are two major issues to address on capitalization rates for institutional industrial investments: 1) financing, and 2) cash flow assumptions.

Financing

First, the lack of capital will continue to be a fundamental problem in the market. For those deals that can be financed, the terms are substantially different than in the recent past. Lower LTV’s, higher interest rates, shorter loan amortizations, and higher equity return requirements will result in higher capitalization rates.

Below are three scenarios. The first scenario is typical of a leveraged deal in 2007.

The next scenario shows how in 2008 loan terms have changed. By increasing the interest rate by 75 basis points, dropping the LTV from 70% to 65%, and decreasing the amortization period from 30 years to 25 years, the OAR increases by 40 basis points.

The concern in term of capitalization rates is that if equity requirements for near term cash flow increase (because there is less upside in value increase and rent growth) then the impact on capitalization rates will be higher.

Capitalization rates have seen unprecedented compression in recent years. This is due to greater leverage and more emphasis on future increases in value or cash flow. These two components have been significantly altered in today’s environment.

Cash Flow Assumptions

Many investment grade industrial properties are purchased based on a cash flow model. The most common is using Argus software to project a 5 or 10-year holding period.

If we hold discount rates and terminal cap rates level, there is still upward pressure on capitalization rates due to more conservative projection being made in today’s environment versus a year ago.

The Impact of Cash Flow Assumptions on Cap Rates chart is a case study analyzing a fully occupied 400,000+ SF distribution building with long-term NNN tenants using Argus software. Typical assumption for 2007, 2008, and a third scenario in which yield rate requirements go up are presented.

As the chart above demonstrates between the 2007 and 2007 columns, slight changes in cash flow assumptions have a significant impact on the capitalization rate. The impact would be greater if this property in case study did not have relatively long-term tenants.

It is apparent that the market is much more conservative on leasing assumptions and rental rate growth. The biggest question for 2009 is where yield rates (discount rate) will land.

The question of yield rates is difficult to quantify due to many major buyers being on the sidelines or unable to purchase assets at this time. The lack of financing and lower stock values have played a large role. With fewer buyers available, the remaining buyers should have opportunities to purchase assets with slightly higher yields that what they could have purchased in recent years.

In summary, the impact of financing, more conservative cash flow assumptions, and buyer’s able to achieve higher yield rates will push capitalization rates down through year end 2008 and into 2009. Many institutional investors are looking at discount rates from 8.00% to 10.00%, with most in the 8.50% to 9.50% range.

Capitalization Rate Survey

The previous analysis explains some of the why. The survey below is provided by Colliers International. It tracks capitalization rate trends from major industrial markets in the US.

What this means to Distribution/Warehouse Real Estate

In 2009, cash will continue to be king. There will be continued demand for good quality, stable, investment grade industrial products. However, pricing will be a contentious point between buyers and sellers. Many owners of good quality portfolios may hold their assets until some of the uncertainty subsides. Those products most impacted will be value added deals. One-off investments will continue to be in demand; however, there may be limited financing available in the short term for portfolio transactions.

One positive for industrial real estate is that its construction cycle is shorter than other product types. The market is therefore more responsive to soft demand and less likely to see oversupply. This diminishes risk for investors associated with rental rate decline or vacancy problems.

Contact for PGP Valuation’s Industrial Practice Group

If you have questions on valuation trends, please contact me:

Jeff L. Grose, MAI

Portland Executive Managing Director

Industrial Market Reports

  2009 PGP Industrial Market Watch (Puget Sound Area - Washington)

  2009 PGP Industrial Forecast (Portland)

  2009 1st Quarter - Industrial Market Report (Sacramento)

2) Get an Insurance Quote - Are your insurance expenses in line with the market? Many times owners stick with the same insurance plan and company for their community for years and years. Don’t get stuck in a rut. Test the market and shop around to find the best insurance plan for your community. Doing so could save you big not only in NOI, but also give you the peace of mind that your community is adequately insured.

3) Pass Through Utility Expenses – Are utilities expenses eating away at your bottom line? By passing the through water, sewer, and trash expenses on to the residents owners help to protect themselves from overuse and abuse of the utilities by careless tenants. Passing through the utilities expenses to the residents can sometimes be a touchy subject, especially in areas where vacancy is high, so owners have been known to discount the space rent to help mitigate a portion of the increased costs to the residents.

4) Image is Everything - What first impression does your community give to potential residents? The best tenants will be looking for high-quality, attractive communities. Simple practices such as a fresh coat of paint, pressure washing common area exteriors, and picking up trash are all affordable ways that please those paying attention to detail. A few flowers and nice landscaping will also add greatly to your community’s curb appeal.

5) Put Your Best Face Forward - Who is the face of your community? Your choice of staff will be the face of your business. Managers who can give a good impression to potential tenants with charisma and attentiveness, as well as capture your vision of professional service, will attract and retain your tenants and encourage referrals. Capitalize on the great supply of talent swimming in the current job market.

6) Space Rental Income Is Not Everything - How much ancillary income does your community produce? The most successful owners in this industry have recognized that income is not limited to the monthly space rent. Additional income generators include RV/boat storage, pet rent, safe deposit boxes, and a host of other creative ideas. It is also important to look at miscellaneous income items which could include administration fees, late fees, and merchandise sales.

by PGP Valuation Inc MHC specialist Kevin Evers

Despite a slightly rally on April 6th, equity REITs posted a 32% decline in the 1st quarter (FTSE NAREIT Equity Index). In March, REITs we up about 4%.

Shopping center and Industrial REITs were the worst performing sectors, each declining about 41% in the quarter. Manufactured Housing was the best performing sector, declining just 2%. Manufactured Housing is viewed as a more “recession proof” sector, which could benefit as people trade down to less expensive rentals.

We expect continued volatility in REITs over the next couple of months due to commercial real estate fundamentals, which are falling in most property types. If you jump into the sector, make sure you are diversified and only buy companies that have enough liquidity to roll over 2009 debt.

Going forward, our favorite sector in 2009 is Apartments and our least favorite is Office. Apartment owners will benefit due to a growing pool of potential renters and lower turnover. Office landlords are struggling due to the lack of corporate expansion; many companies are reluctant to take on new space until the economy improves.

Office vacancies are increasing in most regions in the U.S. Among our buys are apartment REITs, Equity Residential (EQR) and Mid-America Apartments (MAA), two REITs with minimal 2009 debt maturities and attractive valuations. 

These rates were driven down by equally historically low interest rates spurned by the Federal Reserve Bank’s lowering of the Fed Rate to help jumpstart the economy after the 9/11 terrorist attacks and earlier downturn in the dot.com market. While the lower rates did promote more debt by consumers and made housing more affordable, the subsequent housing boom was not built on solid economic drivers (job gains, increase in exports, etc.) and the run-up in housing prices was not supported. The hastily prepared, adjustable rate loans were bundled together and sold on Wall Street, incorrectly rated and sold to uninformed investors. The US economy, that was held up primarily by the housing market (mortgage companies, lenders, developers, home-builders, contractors, etc. all experienced substantial growth over this period) became very unstable when supply exceeded demand and home prices began to fall. Concurrently, the adjustable rate loans began to see large rate increases that the unqualified buyers were unable to keep pace with. As housing prices declined, borrowers were unable to refinance their loans resulting in defaults. The loans sold on Wall Street were spiraling in value and almost overnight, investors in the large conduit loans stopped buying the paper. Lenders that were not prepared to carry and service the massive amounts of residential and commercial paper were now burdened with loans that had no buyers at rates that were too low to sustain.

The mounting loans that were going into default coupled with the growing uncertainty surrounding the economic outlook and crashes in the global economy caused many banks to stop lending altogether. In late 2008, the Federal Government again interceded to create TARP, a $700 billion dollar bail-out for many of these lenders that had created the market instability, fearing that these companies collapse would spark further economic decline through job losses, lower retail sales and a further decline in housing prices. The government’s primary concern was the lending environment had seized up after Wall Street stopped buying paper. The uncertainty on the part of lenders continues today with some lenders quoting 600 to 2,000 basis points over the historically low Treasury rates for new loans, with only the most qualified buyers and the safest of loans being written. At the same time, loan to value ratios decreased from 90% to 100% down to 50% to 60%.

As a result, only well capitalized buyers even qualify for a loan in the current environment. While sellers have been reticent to sell, since few buyers are even less credit are available for deals priced below 7.0%, qualified buyers have realized that they now control the market and many also fear the uncertainty surrounding pricing. Investors have reported equity return requirements near 12% with limited risk to venture from the sidelines. Consequently, a stalemate between buyers and sellers has taken hold of the commercial real estate market. The standoff will likely continue until sellers, some that have already lost up to 20% in book value on their investments, need to either refinance their existing loans or cannot afford the new payments as rates adjust upwards and, in either event, are forced to sell.

In a published article by Royce Rowles of PGP Valuation Inc, Royce discusses the ratio between annual net income and sales prices.

“While the NOI may be falling at many properties (due to increased vacancy rates and/or more competitive rental rates), it almost certainly does not account for the entire value decline in this market. Major value declines also come from the changing status quo between buyers and sellers. Buyers have become much more patient and are expecting a much more favorable ratio between their NOI and purchase price. In other words, when there are fewer buyers (as often is the case in a down market) capitalization rates move upward. In situations where there are recent comparable sales, anyone valuing a property can easily extract and apply very current and realistic capitalization rates to estimate Market Value. This is because during times of appreciation, the market is usually active. Extracting supportable capitalization rates is easy. However, when transactions are scarce finding market capitalization rates can be significantly harder. When this happens, oftentimes sellers have an unrealistic opinion of value because they are relying on dated capitalization rate sources.”

The following is a sample of recent manufactured home community sales collected from across the United States by PGP Valuation.

Real Estate Taxes: Every state has its own method for calculating property taxes. There are several states (like Michigan and California) that reassess facilities based on sales price. Therefore, since the definition of “Market Value” assumes a sale, appraisers are forced to use an amount calculating the value of the property and the tax rate. Each local jurisdiction must be reviewed and understood. This can oftentimes cause headaches for refinances.

Insurance: Rates are fairly similar across the nation. Special consideration should be given to flood, earthquake, hurricane, or other natural disaster areas. Typical range for this category is $75 to $125/space. It is typical for lower rates to be achieved through blanket policies. It will be interesting to see if or how much policies rise over the next couple years due to a variety of factors.

Utilities: Both location and climate play a role in this category. Densely populated areas typically see higher energy costs. Utility expenses can range greatly from property to property depending on the utilities that are directly billed to the residents. Additionally, many owners recapture the utility expenses by passing through the costs to the residents.

Repairs and Maintenance: This category includes landscaping and any maintenance associated with the facility. Areas that require a snow removal expense are typically higher. Long term expenditures are also affected by climate; however, these expenses are typically covered in the reserves category. It should also be noted that expenses for this category can range greatly depending on the number of amenities such as clubhouses, pools, and playgrounds. This expense is also impacted by whether or not the community has a well and/or septic system which requires regular maintenance. The typical range for this category is $150 to $350/space. Age and physical characteristics also play a part in budgeting for this category.

Off-Site Management: This is typically done on a percentage basis (EGI). Therefore, areas with higher rents result in higher management costs. Typical costs range from 3% to 5% of Effective Gross Income. This expense is not to be confused with General/Administrative expenses.

On-Site Management: This category is greatly impacted by location and average living expenses. It is common for resident managers to live on-site. Expenses are often higher for facilities not offering living accommodations for managers. It is typical for owners to offer one free space for managers of communities from 20 to 150 spaces and two free spaces for communities with more than 150 spaces. Typical range for this category is $300 to $400/space.

General/Administrative: This category is fairly comparable from region-to region. This expense includes accounting, legal fees, other professional fees, and general administrative costs. Typical range for this category is $100 to $200/space.

Reserves: This category takes into consideration capital improvements over a holding period. For manufactured home communities, it would typically include replacing the roofs on clubhouse, resurfacing the streets, and updating/replacing utility pedestals. Typical range for this category is $30 to $60/space

(Data compiled by PGP Valuation Inc MHC specialist Kevin Evers)

Unemployment has reached a level not seen since the early 1980s, and the credit crunch has put a pinch on residential and commercial real estate.

With all the bad news in the market, what is the impact on Manufactured Housing? As one of the best affordable housing options, will this sector benefit from the collapse in the housing bubble?

Will rents be able to hold their ground, and can occupancies increase while our nation seeks quality affordable housing?

Many community owners indicate challenges in refinancing communities, and financing homes. The elimination of the CMBS market has effectively removed much of the needed liquidity that the industry runs on.

Have the market ills had an impact on value? Is it possible that MHC is a great hedge against a declining market, and therefore values can be expected to increase? Or will MHC values suffer losses similar to other residential and commercial real estate? We at PGP look forward to talking with you regarding these and other issues facing the industry.

Beginning in 2008, and carrying over into 2009, market conditions have led to a noticeable increase in capitalization rates.  These trends are a function of increased risk perceived by investors and more stringent lending conditions implemented by financial institutions.

As will be shown on the following pages, based various sources, capitalization rates have increase from about 50 to 150 basis points during the past 12 to 15 months. The result is that property values have declined commensurately. 

The upward trends in capitalization rates are evident from several different perspectives:

1. The most common method for analyzing capitalization rate from a financial position is the Band of Investment Analysis.

Also known as the mortgage equity analysis, this technique divides the net income between debt and equity positions. Available financing and required investor equity dividend rates are the components of this analysis. Current loan terms would be in a range of:

Mortgage Ratio:                                                     65%

Amortization Period:                                         25 years

Mortgage Interest Rate:                                         6.5%

Mortgage Constant:                                            0.0810

Equity Dividend:                                                 0.0800

These terms are used in the mortgage equity calculation, which is presented below:

BAND OF INVESTMENT TECHNIQUE
Component	%	X	Rate	=	Weighted Average
Debt	65%	X	0.0810	=	.0527
Equity	35%	X	0.0800	=	.0280
					.0807
Indicated Rate					8.1%

Mortgage Ratio:                                                     75%

Amortization Period:                                         25 years

Mortgage Interest Rate:                                         6.0%

Mortgage Constant:                                            0.0773

Equity Dividend:                                                 0.0700

Using these terms in the mortgage equity calculation, the indicated capitalization rate is 50 basis points higher:

BAND OF INVESTMENT TECHNIQUE
Component	%	X	Rate	=	Weighted Average
Debt	75%	X	0.0773	=	.0580
Equity	25%	X	0.0700	=	.0175
					.0755
Indicated Rate					7.6%

This analysis shows that even a slight change in the interest rate, or loan to value ratio, places upward pressure on the capitalization rate.

2. Comments from brokers in late 2008 and early 2009 indicate rates have increased about 100 basis points in the past 12 months, meaning a property that once traded at a 7.0% cap rate would now sell for 8.0%. 

One broker with Capital Pacific commented in March 2009 that rates for triple net leased real estate would likely be in a range of about 7.5 to 8.5%.

Another retail broker, Kevin Hemstreet, sold two triple net properties in August and September 2008 at cap rates of 6.6% and 6.9%, felt that cap rates would be between 7.75 and 8.0% today.

3. Korpacz Investor Survey, is a national survey of real estate investors and portfolio managers which shows a similar trend. The survey results pertaining to the National Net Lease market from the 1st Quarter 2009 are summarized below:

Source: Korpacz, 1st Quarter 2009  Investor Survey

This data reveals that average capitalization rates for the National Net Lease market have increased about 95 basis points over the past year. 

4. Regional net lease sales also provide strong evidence of upward trends.  Investor purchases of fast food restaurant buildings with triple net leases are charted below. 

TRIPLE NET LEASE SALES (1/08 TO 1/09)
Sale					Year			Cap
Date	Tenant	City	State	NRA	Built	Sale Price	PPSF	Rate
1/22/08	Carl’s Jr	McMinnville	OR	2,657	2007	$1,820,000	$685	6.0%
2/15/08	Izzy’s	Salem	OR	5,154	1982	$1,750,000	$340	5.0%
3/3/08	Starbucks	Syracuse	UT	1,750	2007	$1,300,000	$743	6.2%
4/4/08	Applebee’s	Pasco	WA	5,415	2005	$2,625,000	$485	6.9%
4/24/08	Jack in the Box	Grants Pass	OR	2,662	2006	$2,120,000	$796	6.2%
5/22/08	KFC/Taco Bell	Port Angeles	WA	3,200	1990	$1,335,000	$417	6.0%
6/3/08	Jack in the Box	Vancouver	WA	2,654	2007	$1,215,000	$458	5.6%
7/23/08	El Pollo Loco	Vancouver	WA	2,844	2008	$2,600,000	$914	6.7%
8/22/08	Jack in the Box	Klamath Falls	OR	3,000	2007	$2,400,000	$800	6.5%
9/23/08	Arby’s	Grants Pass	OR	2,700	2008	$2,100,000	$778	7.1%
12/1/08	Shari’s	The Dalles	OR	4,950	2008	$1,800,000	$364	7.7%
1/29/09	Taco Johns	Kennewick	WA	1,768	1981	$857,000	$485	7.3%
	Source:  PGP Valuation/Capital Pacific

On the following chart, the above data is plotted into a regression analysis, which clearly shows the upward trend in cap rates.

Based on this data, as of about one year ago, capitalization rates were about 5.75% and today would be about 7.5%. 

5. Impact on Value The relationship between capitalization rates and value is inverse and can be significant because capitalization rates are a highly sensitive input into the calculation of value.  Therefore, a slight increase in capitalization rates can have a dramatic downward effect on value. 

For example, if a property generating $100,000/year in NOI was purchased early 2008 at a 6.5% capitalization rate, the sale price would have been about $1,540,000 ($100,000 / 0.065).  Today, at a capitalization rate of 7.5%, the value would be about $1,330,000 ($100,000 / 0.075).  That suggests an erosion in value of $200,000, or about 13% ($210,000 / $1,540,000).

6. Looking ahead investors surveyed in the 1st Quarter 2009 Korpacz Investor Survey said they expect rates to increase another 50 basis points over the next 6 months. Again, these upward increases in cap rates are tied to economic conditions and more stringent lending requirements.