Today, we are caught in a worldwide pandemic that has, at least temporarily, locked down most of the global economy. Everything is closed and people are staying at home.  Obviously, other than shopping for necessities and household items, online, most people are not thinking of “going shopping”.  This should suggest that consumers will not be buying autos or homes as it is usual to postpone major purchases when things, including the future are unknown.

The direct result right now should be expected to be a shutdown of demand for autos and homes.  That is just for now and might be expected to have broader effects as businesses have discovered working from home if they hadn’t already discovered it. That along with unemployment could mean falling demand for office space and the possibility of missed rent payments due to the economic shutdown.  Stores, except essential services are closed.  That means that save for online sales retail merchants have no customer foot traffic and minimal sales by comparison to more normal times.  Thus, there is danger that many retail businesses may not make it through this crisis. Even when the crisis ends there may not be a rapid resurgence of demand for cruise ship bookings or hotel occupancy for other than mandatory travel.  People emerging from this should be expected to defer any travel until THEY feel comfortable that any appearance of normalcy is for real and sustainable and not just a “dead cat” bounce.

These concerns and hundreds more should  tell us that no real estate professional has any more than a “gut feeling” as to the worth of any property. There is no current data to review and no recognizable demand to study. Often, we are able to draw from past experience to develop a view of the future but the present situation is like nothing else we have ever experienced.  The only lessons seem to be that eventually things turn around.  But the missing data point is “WHEN”.

To provide a historic backdrop for the analysis some history may be relevant. In 1979 the real estate economy faced a major change when the Federal Reserve, in a midnight Saturday night meeting adopted a very major increase in the interest rates that saw mortgage interest rise above 15% or more in some cases. From 1990 to 1997 there was a major real estate recession attributable to the S & L’s, where one culprit was the practice of brokered deposits bringing in to the industry monumental transfers of cash to secure the bank account insurance unavailable in a current bank because of the limit insured. The S & L’s had to put that money to work resulting in a competitive lending environment where many safeguards were bypassed.  In 2000 – 2001 “Dot.com” bust and the Twin Towers attack sent negative shockwaves through the U. S. economy.  The only real thing that each of these events seems to have had in common was the causing of a major disconnect between economic data points before and after the event. One way to think about it is the mindset one would anticipate when a World War (like WWII) starts. The difference between economic data on December 5th, 1941 and December 8, 1941 (the firs business day after the Pearl Harbor attack) was incalculable because no data existed upon which to extrapolate forecasts. The first two events were national events while the third was international.  However, in the case of WWI, Europe had been involved since 1939 and Asia had been un upheaval long before that.  By contrast the current pandemic is an international event that spread rapidly and uncontrollably from Asia to America to Europe and the world in a matter of a month or so. None of our nation’s previous experiences provide anything that can be looked to for guidance. It must be expected that it will take substantial time for enough new, current data to develop before analysts will have a reliable approach to forecasts. The uncomfortable truth is that right now absolutely no one has any reliable basis for determining the current value of any piece of real estate. The market value of real estate, as measured by appraisers, is its value as of a DATE CERTAIN.  Appraisers can still measure value as of a date before the knowledge of the current crisis became public information but not as of a date after that.  The only discussion that might be currently valid is a discussion of what is possible or probable and why that is so.

Addressing the single-family home market first, seems to be a logical starting point. But, first let’s take a tangent and discuss what must be concerning to many homeowners. Should I sell now to try to protect my profits? The best answer is NO. Any negative impact of the COVID-19has already been built into the market and represents the worst shock to value.  Anticipate that markets often overreact to negative news.  Unless it is mandatory to sell now for reasons like a mandated move, it would be a better bet to wait until this crisis is over before contemplating sale.  And, if a home is listed for sale right now, consideration mightd be given to taking it off the market. Overexposing a property (keeping it on the market) when there is no activity) may ultimately put downward pressure on prices.

During periods of market disruption, speculators make up whatever demand there is, and the speculator hopes to buy at a bargain price anticipating a big re-sale profit when the market improves, which it eventually will. Panic selling or selling to low speculative offers is not a recommended course of action unless there is no other alternative. But, if inability to make mortgage payments is the main problem, rational thinking would dictate that the government would initiate some form of payment suspension which would suggest waiting before taking any action.  If there is no safety-net provided (which would be illogical to assume), the first step might be to contact the mortgage lender and try to enter into a “workout agreement’ under which the lender agrees to modify payment terms that will avoid the necessity of foreclosure.  If lenders learned nothing else, they collectively may have learned that foreclosure is not necessarily a useful or sensible problem-solving tool, on a macro basis, unless the lender views the debt as uncollectable in any form. Lenders might wish to consider the foreclosure remedy on a case by case basis rather than an applicable policy basis. Lenders would generally be better off with a “workout agreement” that avoids putting a loan into default and triggering foreclosure. Widespread foreclosures would only lead to an increase of “troubled” property on the market rather than a step in resolving the economic crisis.

But, none of this discussion addresses the question of the current value of the single-family residence. Value in the single family market is primarily dependent on a reasonable sample of current sales of comparable properties and no dependable sales data can be expected to exist until the market returns to a somewhat active status. That could take some time.  First, second homes will be slower to recover for obvious reasons, thus the date of their recovery will be further into the future. The recovery of sales of primary homes will depend on a recovery in the job market to provide potential buyers not only willing to buy but, most importantly, ready to buy. As of today there is no basis for forecasting when the employment market will recover sufficiently to induce real demand. Optimism that the market will improve is not misplaced but lacking a reliable time horizon as to when that will happen is a necessary part of any forecast. One can only hope that the government will unleash a massive infrastructure repair and building initiative to very rapidly provide millions of jobs for the unemployed. If that takes place quickly the “light at the end of the tunnel” will be much brighter and may help one see the timing of a sustained recovery. But the real bottom line is that TODAY no one has any reliable basis for determining what any single-family home or condo might be worth today or by a future foreseeable date.

The next property category is the multi-family property market (apartments). With millions of unemployed the population size exerting real demand on rental apartments is greatly diminished. This fact should suggest that landlords try to develop anti-vacancy strategies because the replacement renter group should be expected to have significantly moderated. Anti-vacancy strategies would mean some form of “rental payment workout” rather than eviction for non-payment if not already in place by law. But, with the current rising unemployment there is no reasonable basis for projecting rent increases or the stable amount of vacancy in the future.  The value of multi-family property is absolutely a function of first measuring “stabilized rent” then “stabilized occupancy” and then a reliable forecast of operating expenses under current market conditions. As of right now there is no reliable basis for developing future income projections without which value becomes a guessing game until data is available to support projections. The biggest problem for landlords is not knowing how long the problem will last

The best advice for owners of multi-family properties is to have a strategy for maintaining the highest occupancy rates possible at whatever rent level appears to induce strong demand.  This means avoiding eviction by providing ‘workout agreements” to tenants which may well include temporary or long-term rent reductions.  The worst strategy would be one where the tenant is kept guessing about their future in their home.  In times of uncertainty all renters, and particularly those who are financially vulnerable, are anxious about their futures. That understanding is essential.

The sales of multi-family properties have, up to the virus, been propelled by the excellent past performance of sustained high occupancy and regular rent increases with very low capitalization rates being the norm.  Future occupancy levels and rent levels are not a “given”.  The continuance of low capitalization rates may not a rational assumption because some major fallout must be expected as a result of the elevated risk inherent in the state of current economic disruption. The really good news is that the housing supply, before the crisis, was well below the level of demand and, if nothing else, the present crisis could retard any major new housing initiatives for a while.  Thus, the excess of demand over supply should persist into the recovery phase. The only real question for multi-family properties is whether capitalization rates will remain low enough to support pre-crisis levels. Who knows? But it would seem to be a better bet that the answer will be NO if only because the present economic disruption might be expected to shake down to all levels of the economy.

Brick and mortar retail properties were having trouble before the current crisis arrived and has only been handed a tsunami of new problems to hurt demand. Tenants who were already having problems and many who weren’t should be expected to be forced into bankruptcy if landlords fail to take major initiative steps to avoid such action.  An occupied retail space, where the tenant is likely to remain in business, when the crisis ends, would be preferable to a vacant space. It is axiomatic that a retailer with no on-site sales will not be able to generate cash flow with which to pay rent. The notification of Cheesecake Factory, to all of it landlords, that they would not be paying rent on April 1st was probably just the first sign of what may become the norm.  Internet retail sales do not need a brick and mortar store. Retailers should be expected to develop strategies for marketing and achieving higher volumes by internet sales and if they didn’t already know it, have found out how to increase those sales. With internet sales eliminating the need for a store visit retail property owner might anticipate a difficult period ahead while trying to re-invent themselves. The near-term outlook for retail properties and retail capitalization rates does not appear to be terrific.  Landlords have discovered that even the strongest retailer, in financial terms, is not exempt from a serious downturn and loss of ability to make timely rent payments. Retail properties viewed as relatively risk free have been exposed to risk and that can develop into a lowering of confidence. Today, no one really knows, or can support with data, the probable level of a property value or its anticipated performance in the investment market. Until unemployment problems are resolved there will be no data based upon which to forecast the levels of spending. Another probable impact may be a postponement of new projects as the first focus will probably be the “in-filling” of vacant space. But, the signs to look for will be a resurgence of employment and increased buyer demand for goods.

Office buildings are occupied by businesses many of which are struggling.  Law firms, as an example, have litigation practices that are inactive due to court shutdowns.  Mergers and Acquisitions should be expected to go on the back burner for a while, medical offices are seeing patients on an emergency basis, realtors are experiencing a lack of buyer and leasing activity.  In short, the users of office space are, because of economic circumstances, may be facing reduced income.  And, many firms have found, during the present crisis that working from home is a viable alternative to working from the central office.  This consideration suggests that businesses might be expected to re-evaluate their need and use for office space going forward.  It is much to early to tell what the office sector might look like when it emerges from this crisis.

The travel sector of the economy has been seriously impacted by negativity.  Leaving out the airline and cruise industries as separate problems, hotels depend on travel which depends on both business and pleasure to generate demand for rooms. Now, travel restrictions put in place mean that no demand for room occupancy exists, almost worldwide. The business generated demand might be expected to regenerate when the crisis has passed.  However, depending on the employment picture, vacation travel should probably be expected to take longer to recover. What these considerations suggest is that the hotel/convention segments of the economy should be expected to experience near term problems even after the crisis is over. The question that should be going through the minds of travel dependent real estate owners is whether the present “shutdown” will teach business new tricks for meeting without travel. During these times businesses are still holding business meetings but are doing so via tele-conferencing or similar methods.  Conventions are not as adaptable to “virtual” means and should be expected to be a force but one that may take longer to re-emerge due to the lengthy planning process.

Light industrial (warehouse) space, as a separate investment category, may not face the same adversity as other property types.  An increase in internet purchasing should increase the demand for warehouse spaces from which to ship purchases.  This may be good for that market sector, but it is much too soon to tell.

During the crisis period, fast food businesses, whether freestanding or in retail spaces are possible beneficiaries of the “sheltering in place” economies as they shift to sanitary “take out” service and serve a wide population looking for a way to dine out by dining in.  

The traditional appraisal process usually includes considering the use of the Cost Approach, The Sales Comparison Approach and the Income Approach.  The Cost Approach is probably not close to being reliable for the primary reason that there is no currently relevant data available for estimating the land value component of the approach.  The Sales Comparison Approach is not useful until a sufficient sample of current sales is available for study to guide a value conclusion by that method.  Past sales that took place under totally different economic conditions are not a guide to the present or future market conditions and, because of the changed economy, cannot be reliably “adjusted” to reflect the present. The Income Approach depends on a supportable conclusion as to the sustainable market rent and occupancy level of rental space, which, now lacks any viable data input.  So, the inescapable conclusion is that the traditional tools for valuing property all currently have fatal flaws in terms of reliability.

The valuation of large investment properties most often involve a discounted cash flow (DCF) analysis which is very complex but most importantly requires key assumptions as to many of the study inputs.  The reliability of the inputs used is currently without available support absent significant data availability.  Thus, the DCF model is of questionable reliability.

At the end of the day, appraisers will still be called on to provide appraisals.  However, a strict reading of the applicable standards may well mandate that the appraiser, in rendering a value opinion, will need to discuss the level of reliability applicable to the conclusion keeping in mind that the opinion applies as of a date specific not just any date.  It is not a violation of standards to qualify conclusions as being based on the best available information while disclosing that the information is of limited reliability and why.  

Right now, as of today, no one really knows where the $ value of any real estate really is.  It is possible to forecast, but to do that assumptions must be made and without a solid basis for the assumptions the result becomes a GUESS. An educated guess may be the best available result, but the conclusion must clearly disclose that and not be presented as conclusive. Moreover, in an economy facing a high risk of recession of unknown length or severity mandates that the “educated guess” is logically reasoned and not just based on wishful thinking.

There is an old saying “a smart person knows what they do not know” and that should describe the vast majority of people today. We just can’t know, with a measurable level of certainty what the post crisis value of any individual property is really worth in terms of established valuation standards. What this paper addresses are not intended to point to value or how to measure it.  The most important consideration when faced with “knowing what your do not know” is to consider the myriad of questions that need answers before “not knowing” can convert to knowing”.

© Lloyd Hanford April 2020


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