Ever since the commercial real estate (CRE) market began its decline in 2008 there have been all manner of reports indicating the level of decline. At the outset, market makers generally did not foresee a decline of the magnitude now being reported. However, there have been transactions (or foreclosures) evidencing value declines in excess of 50% or more from the market high in 2006. And, it isn’t only the small, unsophisticated investor being subjected to losses but, rather includes a host of very large, real estate “movers and shakers” like Tishman, Morgan Stanley, General Growth etc. All of this raises the question of the real worth of CRE today. The answer is that no one really knows with any great degree of certainty for a variety of reasons.

In stable markets, real estate appraisers and market makers, among other things, rely on a volume of transactions to provide the market information leading to estimating value. A problem arises when there has been a major economic change that, in effect, causes a disconnect between a past market and the current market. Previous transactions, under these conditions, fail to provide reliable views of current market anticipations. Further, when markets change radically transaction volume slows down substantially as buyers want to pay “tomorrow’s price” and sellers hold out for “yesterday’s price”. In other words, when a market is in a state of decline, buyers are only interested in bargains. On the other side of the table, sellers who have good property with no immediate financing or operating problems are under no pressure to sell and, accordingly, will not offer their properties for sale at bargain prices. Instead they will usually opt to wait until the market improves before selling. The same is not true of property owners facing financing or operating problems. The first strategy of property owners facing difficulties is to try to solve the problem through either a re-financing of debt or a quick sale to preserve their equity. Sales that take place under these conditions do not provide reliable guidance as to the worth of the asset. In cases where the property has substantial operating problems with a concurrent declines in value the problem is compounded when value falls below outstanding debt leading to either a deed in lieu of foreclosure or a foreclosure. If the lender wants to immediately recover some of its investment, the property may be sold at what is considered a “bargain” price. However, many lenders, not under pressure to liquidate assets, will try to manage the asset back to health before placing it on the market for sale. The net effect of all of this is that market activity slows and the transactions that do take place fail to provide reliable indications of value.

Appraisers and market makers also rely on the ability to forecast rents and operating expenses as a guide to estimating the worth of an asset. In stable markets these forecasts can be made with a relatively high degree of confidence in the outcome. But, in markets where vacancies are increasing and rents are concurrently declining (law of supply and demand), forecasting future performance produces results that are developed under conditions of great uncertainty rendering them potentially unreliable.

The lack of adequate sales volume and the lack of stability in market rents and occupancies make it very difficult to estimate value with any great degree of comfort in the results. Accordingly, the valuation process tends to become based more on judgmental conclusions than on conclusions supported by “hard” market evidence. Mortgage holders often obtain more than one appraisal, over a period of time, before reaching a disposition decision. The difficulty of accurately measuring value leads to a certain degree of procrastination by the holders of property (mortgages) particularly when the people responsible for the asset have no, personal vested interest in the outcome of a decision. These patterns existed in the 1990’s when the Resolution Trust Corporation was in control of the assets of failed Thrifts and there is no reason that the same patterns should not emerge now. This may partially explain why opportunistic investors today are finding it difficult to acquire properties at what they consider to be “bargain” prices.

Another contributing factor to a short supply of CRE available for sale is the realization by owners that their yield, even at today’s depressed prices, is significantly higher than could be realized by placing the sale proceeds in an alternative investment.

Many observers believe that there are substantially more troubled assets overhanging the market than are being sold or offered for sale. This should not be expected to change dramatically unless those holding the assets become convinced that a market turn-a-round can not be anticipated in the foreseeable future. If that happens, the volume of troubled assets offered for sale should increase dramatically. On the other hand, if there are sustained signs of improved occupancies and rising rents assets may begin to come to market but not at “bargain” prices. Instead, they will most probably be priced at levels anticipatory of the values that may result from a recovery.

As of the moment, the existing market forces make it difficult to predict the value of commercial real estate with any great degree of certainty or comfort. But, the bottom line is that property is only worth what a buyer is willing to pay at a given point in time. The fact that a seller is unwilling to accept what a buyer proposes is not evidence of value.

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