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.

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

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 real estate industry is responding quickly.  “Sustainability”, “LEED”, “carbon credits”, “cap and trade” are terms that are rapidly infiltrating our day to day conversations with developers, architects and the financial community. 

To maintain a competitive advantage, we will need to provide our clients with knowledge and tools to help them maximize their returns by employing green technologies.  Enhanced value will manifest itself through lower operating costs, faster lease-up and more aggressive cap rates.

At PGP Valuation, our Sustainability Practice Group has been networking with our partners at Colliers CMN to build a diverse and knowledgeable team to assist our clients with decisions about sustainable development.

Our offices in the Pacific Northwest are well positioned to take the lead in this emerging sector, as our region has been ahead of the curve:

• As of 2007, Portland and Seattle each had about the same number of LEED certified buildings as New York City, Los Angeles and San Francisco combined. 
• Seattle was the first city in North America to establish a LEED standard for all public buildings.

The benefits of building green will be social, environmental and economic.  Commercial buildings, because of their large size, can make a measurable contribution to the sustainable movement.  PGP and Colliers can be the market leaders in valuation and brokerage of green buildings.  Future generations will be the beneficiaries.

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.

Introduction

There is broad sweeping change in the mindset of the World economy caused by the credit crisis, economic downturn and long-term uncertainty, which is having a profound impact on the real estate market. Our job as appraisers is to interpret what is occurring in the economy including supply/demand conditions, unavailability of financing, rising unemployment and alternative investment vehicles in order to credibly estimate the value of real property. The following information provides an introduction to the commercial real estate appraisal process, and summary statements with regard to how we are adapting our analysis to the changing economic conditions.

Appraisal: (noun) the act or process of developing an opinion of value; an opinion of value.  (adjective) of or pertaining to appraising and related functions such as an appraisal practice or appraisal service.

Appraiser: one who is expected to perform valuation services competently and in a manner that is independent, impartial, and objective.

Appraisal Process

1) Define the problem

• Identify the real estate
• Identify the rights to be valued
• Establish the intended user of the appraisal
• Determine the definition of value
• Determine the effective date of the appraisal
• Identify the scope of the appraisal
• Establish any assumptions and limiting conditions

2) Preliminary Analysis and Data Collection

3) Highest and Best Use Analysis

4) Land Value Estimate

5) Apply the Appropriate Valuation Techniques (Cost, Income, and Sales)

6) Reconciliation of Value and Final Value Conclusion

7) Report the Defined Value

Scope of Work: the type and extent of research and analysis in an assignment.

The scope of work is defined by the appraiser and the client.  However, the appraiser can not limit the scope of work to such a degree that is jeopardizes the reliability of the value conclusion.

The most common value scenario requested is the As Is Market Value.  Market Value is defined below:

The most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently, knowledgeably, and assuming that the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby:

1.     Buyer and seller are typically motivated;

2.     Both parties are well informed or well advised, and acting in what they consider their own best interests;

3.     A reasonable time is allowed for exposure in the open market;

4.     Payment is made in terms of cash in United States dollars or in terms of financial arrangements comparable thereto; and

5.     The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.

Office of Comptroller of the Currency (OCC), Title 12 of the Code of Federal Regulation, Part 34, Subpart C – Appraisals, 34.42 (g); Office of Thrift Supervision (OTS), 12 CFR 564.2 (g); This is also compatible with the RTC, FDIC, FRS and NCUA definitions of market value.

The scope of work may be defined by the appraiser, however, the scope of work must meet or exceed 1) the expectations of parties who are regularly intended users for similar assignments; and 2) what an appraiser’s peers’ actions would be in performing the same or similar assignment.

Appraisal Reporting Options

An appraiser has 3 options for written reports:

Self Contained

Summary

Restricted Use

Three Approaches to Value

• Cost Approach
• Income Approach
• Sales Comparison Approach

Cost Approach

The cost approach is based upon the principle that the value of the property is significantly related to its physical characteristics, and that no one would pay more for a facility than it would cost to build a like facility in today’s market on a comparable site. In this approach, the market value of the site is estimated and added to the estimated depreciated value of the improvements.

Or

Replace Cost of Improvements w/ profit – Depreciation + site value = Cost Approach Value

Replacement Cost New

All costs to construct

• -Direct Cost (materials, labor, contractor overhead)
• -Indirect Cost (perm. financing, marketing, professional reports)

Sources for Data: Developer’s Budget, Cost Comparables, Marshal Valuation, Bids

(+) Profit

Sufficient entrepreneurial incentive to compensate risk

• -Varies based on market sector

Developers (10-20%)

Users (5%)

Sources: Market survey, alternative investments

(-) Depreciation

Three Types

• -Physical (typical wear & tear)
• -Functional (obsolescence due to design)
• -Economical (surrounding influences)

(+) Land Value

Cost of equivalent substitute site

• -Valuation techniques

Sales comparison (most typical)

Residual analysis

= Cost Approach Value

Most Applicable for:

• New or proposed construction
• Owner/user properties
• Special purpose properties

Limited Application for:

• Investment properties

-mostly to test financial feasibility

• Older construction

-difficult to measure accrued depreciation

Cost Approach in a Declining Market

Many new projects are not financially feasible.  The lease-up or absorption/sell-out of a project becomes extended.  Many projects appraised 18 months ago that are nearing completion are no longer profitable due to extended marketing periods.

Replacement cost becomes a less reliable indicator of market value.

Land value assumptions change. In an active construction market, land is purchased for immediate development. If a development parcel is purchased now, the buyer’s assumption would be to hold until development is feasible.  Additional holding costs may require a downward adjustment to the land sales that sold in 2007.

Income Approach

In the Income Approach a property’s capacity to generate income is analyzed, which is in turn capitalized into an indication of present value. Two fundamental methods are used in this approach, Direct Capitalization and Yield Capitalization, which are described below:

• Direct Capitalization Method – The advantages of direct capitalization are that it is simple to use, easy to explain, often expresses market thinking, and provides strong market evidence of value when adequate sales are available. Direct capitalization is most commonly applied by applying an overall capitalization rate to relate value to the entire property income (i.e., net operating income).
• Yield Capitalization Method – This method is typically referred to as a Discounted Cash Flow Analysis. Market supported assumptions and projections are made for future changes in occupancy, rents, income, and expenses to arrive at periodic cash flow. The property’s eventual reversion is also estimated, incorporating anticipated changes in the property and market conditions. The resulting cash flows are discounted to a present value indication using an appropriate market supported yield rate.

Direct Capitalization – Most Commonly Used

The following steps create a basic outline of the income approach:

• Estimate income
• Estimate Vacancy and Expenses
• Derive an estimate of Net Operating Income (NOI)
• Derive a capitalization rate from a) market sales, b) band of investment analysis
• Divide the NOI by the Capitalization rate to estimate the value

The fundamental principle in this approach if anticipation.  The anticipated risk associated with the income stream is implicit in the cap rate.

A basic Income Approach is:

Potential Income – Vacancy = Effective Gross Income

Effective Gross Income – Expenses = NOI

NOI /Capitalization Rate = Value

Limitations - The limitations of this approach include:

• Lack of recent, directly comparable rental rates
• Lack of market transactions from which to derive a reliable capitalization rate

Common Mistakes - Common mistakes made by market participants include:

• Understanding the difference between current income and potential income and between fee simple and leased fee value
• Estimating appropriate expenses
• Understanding the structure of the leases in order to measure appropriate expense reimbursements when applicable
• Deriving an appropriate capitalization rate based upon the risk factors of the property

Income Approach in a Declining Market

The Income Capitalization Approach is the best measure of value for income-producing investment properties. One challenging task in the current economy is accurately estimating market rents, which requires the appraiser to measure the impacts that softer market conditions are having on rents.

Without a doubt, the most difficult and important modifications to our appraisals are occurring in the capitalization and discount rate analysis. Due to the drastic decline in investment sales over the past year, it takes a lot of creative analysis to reasonably estimate current capitalization rates. We look in the rearview mirror on past transactions, consider current listing and review national trends in order to provide the most reasonable estimate.

Sales Comparison Approach

The Sales Comparison (Market) Approach is based on the principle of substitution, which asserts that no one would pay more for a property than the value of similar property in the market. In this approach, the subject property is compared directly with other recent sales of similar properties in the marketplace. This comparison is typically accomplished by extracting “units of comparison,” for example, price per square foot, and then adjusting these units of comparison for the comparable sales for differences between the subject and each comparable.

The reliability of an indication found by this method depends on the quality and quantity of the comparable data found and the ability of the appraiser to make reasonable and supportable adjustments. In active markets with a large number of sales that are physically similar comparables, this approach is generally a good indicator of value.

Sources of Comparable Data

• Buyer
• Seller
• Brokers
• Public records
• Professional data companies
• Multiple listing services
• Other appraisers

Typical Units of Comparison

• Price/SF of gross building area
• Price/SF of net building area
• Price per unit (apartments, self storage, hotels, health care)
• Price per seat (restaurants and theaters)
• Price per door (truck terminals and distribution centers)
• Price per boat slip (marinas)
• Price per parking space (parking decks)
• Price per hole (golf courses)
• Price per lane (bowling alleys)
• Price per lot or pad (subdivisions, mobile home parks, RV parks)

Most Applicable for:

• Owner/user properties
• Special purpose properties
• Any property (retail, office, etc.) where sufficient data is available

Sales Comparison Approach in a Declining Market

Limited sales activity is making the sales approach more difficult. Investment sales are off 60% to 80%.  As much as 50% of those sales now include assumed debt.

The factors affecting value and pricing have changed. This includes buyer’s assumption on the future. For example, capitalization rates at 6% and investors IRR of 15% imply substantial increases in income over a holding period. With flat rents, higher vacancy costs to ownership, difficulty financing, the conditions in which sales took place in 2007 are much different that they are today.

Appraiser now need to do a better job interviewing brokers, analyzing active listings, and drawing a conclusion from possibly older sales prior to 2007.

W. Grant Norling & Jeff Grose, MAI presented the previous discussion with Perkins Coie LLP on Thursday March 19th of 2009. If you would like to meet with them to discuss anything further feel free to get in contact with W. Grant Norling at grant.norling@pgpinc.com

You can view and/or download a PDF version of the above presentation in the iPaper document displayed below.

The creators are commercial real estate appraisers based out of Portland, OR that serve the entire OR market. By default, the articles will be somewhat skewed toward the Pacific NW, and how our local and regional issues relate to the overall national and global real estate markets. If that does nothing for you, feel free to build your own blog.

Enjoy the journey!!!

Way back in November 1996, Oregon voters passed Measure 47. This was a constitutional amendment popularly referred to as the “cut and cap” tax reform act. The “cut” aspect of the legislation referred to a reduction in taxes for the 1997-98 tax year calculated as the lesser of the 1994-95 taxes or 90 percent of the 1995-96 taxes. Bonded debt would be exempt from the calculations. The “cap” aspect of the measure restricted growth in taxes to no greater than 3 percent annually after the 1997-98 tax year.
Exempt from the calculation were circumstances of new construction, significant renovations/rehabilitation, loss of exemption status, change in zoning, subdivision of the property, and omitted property.

When the legislative assembly convened in January 1997, it became evident that, as written, Measure 47 was impractical to implement on an equitable and feasible basis. Measure 50 was the revision of Measure 47 and is the product of a cooperative effort between industry, the petitioner for Measure 47, the Oregon Assessors, the Department of Revenue and the House Revenue Committee. Measure 50 limited the 1997-98 assessed value of each property to the lesser of real market value or the 1995-96 real market value, less 10 percent. Growth in assessed value was limited to 3 percent annually, thereafter. Thus, the 1998-99 maximum assessed value was the 1995-96 real market value, less 10 percent, plus 3 percent. The 1999-2000 maximum assessed value was the 1998-99 maximum assessed value plus 3%, and so on.

In addition to the cap on assessed value growth, tax growth was also effectively limited to a 3 percent annual growth rate, although exceptions are permitted under specially approved levies. Similar to Measure 47, assessed values can be increased due to new construction, subdivision, rezoning, omitted property and loss of exemption. When these events occur, the assessor will place the added value on the assessment roll at the maximum assessed value.

The maximum assessed value of added value will be determined by estimating the real market value of the change and multiplying it by the ratio of the maximum assessed values of like properties to the real market value of like properties.

For example, on December 31, 2007, a new fast serve restaurant was completed. Its real market value is $800,000. The average maximum assessed value for like properties in this class is $600,000 and the average real market value for like properties is $800,000. Therefore, the subject’s 2008-09 assessment (maximum assessed value) will be [($600,000/$800,000) x $800,000] $600,000.

The process is charted below:

The 2009-10 assessed value will be ($600,000 x 1.03) $618,000.

Measure 50 also provided for establishment of new levies outside the tax rate limits. One interesting aspect of the new levies clause was that the levy request required a 50 percent “turnout” of registered voters for approval. Voters overturned this supermajority requirement in 2008.

One significant implication of Measure 50 is the “disconnect” between assessed value and market value. Reliance on assessed value for market-based decision making and matters related to income tax is clearly a phenomenon of the past. There is reason to believe that there will be some level of predictability of future tax obligations based on the growth rate limits. Properties subject to exceptions, particularly new or significantly changed properties, should be monitored closely for their first year values on the tax roll, as these values will dictate the taxable values into the future.

Todd S. Liebow, MAI, is a Principal of PGP Valuation Inc, a National Real Estate Appraisal and Consulting Firm providing Property Tax Appeals/Consultations; Commercial, Industrial, and Special Use Property Appraisals; and Feasibility studies.

A Scrib iPaper version of the document is presented below. Additionally, you can view other publications including recent newsletters and tax information in the Publications section of the website.

If you enjoyed this article and would like to download a PDF copy, you can do so from the link below.

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Over the past five years real market values (RMV) of commercial real estate have generally been increasing in sync with the growing economy, which has led to a corresponding increase in assessed values and therefore an increase in property taxes. However, due to the recent decline in property values (RMV) in the past year due to the smoldering recession, many properties, especially newly constructed or renovated properties are over valued, resulting in the over taxation of property owners. Due to the methods applied by the county assessor, if a newly constructed property is assessed at the beginning of an economic downturn, then there is a high probability that the property will be over assessed as the assessor typically bases the value on past sales or recently negotiated leases.

If you are a property owner and you own more than one property, these additional taxes could exceed $10,000, $30,000 or higher per year. Additionally, during a booming economy vacancy rates typically stay low and property owners are not exposed to the risks posed by vacancies; however, in the current economy, many property owners are left footing the tax bill when their tenants vacate and potentially move to competing locations with lower triple net charges (taxes, insurance and common area maintenance charge). It should be noted that property owners can get their properties reassessed (through a tax appeal process) if they feel their properties are over-valued. If the RMV as determined by the county assessor exceeds what the property would easily sell for in an open market (MV) then property owners should file a property tax appeal (see your local county Assessment and Taxation website for details on the tax appeal process). Generally speaking, if the property is affected by a decrease in value caused by: (a) declining prices and market conditions; (b) damaging conditions like dilapidated roofs, cracked slab, construction defects, condemnation, obsolescence, environmental problems or (c) other causes; then property owners should file an appeal. The savings to property owners will more than likely pay for the fees associated with getting the property appraised.

The cut your losses approach is not an option many property owners want to follow. If a property was bought recently then the property was likely bought at a high point in the market; leaving many property owners losing money if they sold now. However with property values falling quickly, this approach may be the best option for those property owners who are looking to hold onto properties in the short term.