Many real estate changes are now\ntaking place, simultaneously, that might, singly or together, represent\npotential, major \u201cgame changers\u201d (agents of change) to the future of real\nestate and thus real estate appraisal. The agents of change include, without\nbeing limited to: increasing homelessness, material decline in demand for\n\u201cbrick & mortar retail properties, globalization of real estate ownership, changes\nin the environment for office space and globalization of real estate ownership,\nto identify some major items. Despite these observable phenomena there does not\nseem to have been much major discussion as to how the appraisal profession may\nneed to analyze and address these changes. Suffice it to say that, in over 50\nyears the study of real estate valuation has focused on improving methodology\nand professional standards. The integration of computers and innovative,\ninteractive programs have facilitated material forward progress and the\ndevelopment of detailed, mandatory uniform standards have provided greatly\nenhanced credibility for the work product. However, there has been a complete\nabsence of any new valuation theory discussion. \nThe profession is still working with the three approaches to value\n(Cost, Comparable Sales and Income) although the methodology has changed significantly\nand for the better. The changes taking\nplace may or may not suggest that an academic critique of present theory and\nmethodology needs to take place to make sure that, moving into the future, the\ntheories and methods in use are the right ones and provide a measurable level\nof reliability and relevance<\/p>\n\n\n\n
The purpose of this paper is to\nexamine the changes (causes and effects) taking place with the objective of\nstimulating the kind of thinking and research necessary to develop enhanced appraisal\nmodels, methods and theory needed to sustain the future of real estate\nvaluation as a profession. For the active, practicing appraiser this paper\nprobably doesn\u2019t have much in it that they haven\u2019t thought about, but thinking\nabout and raising issues are two different things. As a biproduct an attempt\nwill be made to examine some possible solutions to some problems.<\/p>\n\n\n\n
HOMELESSNESS: In the last few\nyears most people have become aware of the growing homeless problem but there\nis a lack of understanding as to the underlying reasons for the problem. There are multiple related and\/or unrelated\ncauses. First, not all homeless people are victims of the same cause.<\/strong><\/p>\n\n\n\n LACK OF HOUSING ALTERNATIVES: Many counted as homeless are\nin that state because they can\u2019t find any affordable housing. In many jurisdictions this observed problem\nseems to be caused by a lack of enough building of new housing supplies. A shortage of supply faced with rising demand\nleads to increasing rents and housing prices. At some point the potential renter\nor buyer is priced out of the market and living on the street becomes the\nhousing alternative. <\/strong><\/p>\n\n\n\n MENTAL HEALTH PROBLEMS: Mentally ill people without support,\nresources or available treatment alternatives add to the homeless increase\nbecause there is no other alternative and they often require specialty housing\nin facilities that are different from conventional housing.<\/strong><\/p>\n\n\n\n DRUG ADDICTION: Part of the homeless population are\nsubstance abusers who may need specialized intervention and living facilities.<\/strong><\/p>\n\n\n\n The same causes of being\nhomeless do not apply to all of the homeless population.<\/strong><\/p>\n\n\n\n CAUSES: The common\ncause of homelessness is a lack of housing supply. For the renter without\nenough money to consume a rental unit, a mentally ill person or a substance\nabuser it is the same cause albeit the mentally ill and substance abusers\nrequire different types of housing alternatives.<\/strong><\/p>\n\n\n\n Inadequate housing supply, in many jurisdictions, is the\nresult of flawed land use and zoning policies. \nIn San Francisco, for example, the City down zoned properties in the\nlate 1970\u2019s resulting in a 50% reduction of previously allowable densities This\nwas at a time when builders were eager to build and the change effectively\ndiscouraged development. In addition, the codes became more restrictive with\nthe addition of requirements (like providing a percentage of affordable\nhousing) that were unrelated to health and safety. The net result was a\ncurtailment of potential, new supply. So, in effect, the leaders of the time\nreacted to citizen anti high-rise pressures instead of understanding the\nnegative result on the future of what they were creating. Then, San Francisco,\nin 1978 created a strict residential rent control ordinance that effectively\ncreated two classes of renter. One class were the renters that were living in\nwhat became controlled rental units protecting the current occupant. The other class were renters without\nprotection such as those who occupied units built after the date of the\nordinance. Finally, the City instituted a cumbersome, lengthy and very\ndifficult permit process adding significant costs to project development.\nDespite what turned out to be the misguided belief of the Planners that the\ndeveloper absorbed these costs the developer merely passed all of these added\ncosts on to the consumer.<\/strong><\/p>\n\n\n\n SOLUTIONS: The only obvious solution, as things now stand,\nwould seem to be for effected localities to induce, over time, a massive increase in supply. Accomplishing\nthis would necessitate a revision of land use and zoning policies designed to\nsubstantially increase height limits (wherever practical) and allowable\ndensities. Modernize all codes to spell out what limits are permitted. At the\nsame time all requirements having nothing to do with health or safety need to\nbe reviewed with a removal of those requirements adding cost to the project but\nnot enhancing the housing experience. Finally, remove all public hearings in\nthe approval process unless a material variance from code is sought. The permit\nprocess needs to be expedited and taken out of politics. An example of the\nhousing problem is the fact that many communities have experienced runaway\nprice increases for single family housing. The result is that the price of a\nhome has become so high that potential buyers can\u2019t afford to buy yet the\nneighborhoods remain zoned for single family use. In terms of the future, the\nzoning must be changed to allow higher densities. There appears to be only one major City\nstudying that solution at the present time. <\/strong><\/p>\n\n\n\n These steps might take years\nto resolve the supply problem but increasing supply is the only obvious solution.<\/strong><\/p>\n\n\n\n FUTURE: If the housing problem is not addressed aggressively\nthe result may well be an extinction of the cities as we know them. Cities\nrequire an available of army of service workers, at every employment level and\nreasonable commute distances to the workplace. When workers can no longer find\nhousing and commute problems become unacceptable cities will begin to die. Signs of this are beginning to be evident in\nthe hotel and restaurant sector where the availability of lower service level\nemployees is forcing operating cost problems. The solution for hotels might be\nto devote some of their rooms to workweek housing for those employees. Restaurants don\u2019t have that option readily\navailable and can only compete for employees through wages and the economic\nimpact of that option may negatively impact economic viability. <\/strong><\/p>\n\n\n\n In order to solve these\nproblems expert study roups should be appointed with the charge of providing\ndetailed analysis of the observed problems along with developing a roadmap for\nsolutions. Solutions will be long term involving a two year or longer\ndevelopment time so the appointed group might also be charged with developing\ninterim solutions, in six months or less, designed to immediately induce major\nshort term additions to the housing supply. Failure to take this step now could\ninevitably lead to the death of a City as those necessary service workers will\nno longer be able to live in or near the City and provide all their\nservices. What then? How will future\nappraisers deal with these problems?<\/strong><\/p>\n\n\n\n RETAIL: The retail revolution now taking place didn\u2019t\njust happen. The probable precursor may\nhave been the emergence of \u201cbig box\u201d stores consisting of huge, warehouse\nstores like Costco Walmart and single purpose retailers like Best Buy. These\nretailers not only changed the way business was done but also adopted the\non-line sales strategies to increase their sales. The advent of widespread,\non-line shopping has allowed consumers worldwide to shop any brand or product\nwithout leaving home. Retailers can quickly expose their products to consumers\nvia well developed websites, print media and television advertising without\nneeding a global network of brick and mortar stores. The game\nprobably began to change with the national and international expansion of\nretail brands either directly or via franchising. This change caused the\ndiminution of the viability of small, local retailers. Today there are few, small, independent\nretailers or family owned department stores remaining as most have been\nabsorbed by major chains, gone out of business or bankrupt. The incursion of\non-line shopping changed the dynamics of major department stores to the point\nthat some are now struggling financially. Department stores and large \u201cbig box\u201d\nretailers have been exiting business faster than new stores are opening with\nthe most recent being the Sears announcement of store closures and Barneys\ngoing out of business. Bankruptcy of a\nmajor retailer was a very infrequent occurrence but is now not unusual. This\nproblem is negatively impacting both stores located in Central Business\nDistricts as well as neighborhoods. In\nmany parts of the country retail vacancies are pervasive and present problems\nfor their communities. The bottom line is that demand for retail store space\nhas declined and continues to decline. These factors operate to change the\nrisks of retail property ownership due to increased vacancy risk as well as the\nimpact of this problem on capitalization rates.<\/strong><\/p>\n\n\n\n CHANGES: Some of the\nchanges have caused the creation of new models. It had been observed that young\npeople like to \u201chang out\u201d at the Mall and that adults like to \u201cgo out\u201d. The result of this is that specialty shopping\ncenters focusing on the entertainment sector (like motion picture theaters) are\nenjoying success while other types of shopping centers are not. As available as\nmovies are on TV, there is no substitute for the large screen. And there is no\nquestion that \u201ceating out\u201d is an increasing phenomenon with both fine dining,\nfast food and everything in between being popular. Specialty centers with multi-screen motion picture\nfacilities coupled with many restaurants have, so far, been successful in\nattracting tenants as well as customers.<\/strong><\/p>\n\n\n\n Not all store types found in\nshopping centers can benefit from internet sales. Supermarkets, liquor stores,\nbarbers, beauticians including a range of types like nail salons, spas, shoe\nrepair etc. will still need brick and mortar space. In other words, if\nsomething is needed in less than 24 hours a store may be the best answer.<\/strong><\/p>\n\n\n\n In many parts of the Country\nshopping centers may have been overbuilt with no infill tenants available to\noccupy vacancies. In shopping centers, the \u201cin-line\u201d stores depend on the\n\u201canchor\u201d (most often a department store or big box store) and when the anchor\nvacates the in-line stores lose their customer draw. Some centers have leases\nwhere the in-line shops can opt for early lease termination if the anchor\ntenant vacates.<\/strong><\/p>\n\n\n\n On-line shopping giants like\nAmazon create a new set of problems as their increasing sales lead to traffic\nand congestion problems resulting from the massive number of package\ndeliveries. Whether this problem can be solved by an increase in drone\ndeliveries (in place of surface street deliveries) or not remains to be seen.\nHowever, the increase of on-line shopping may increase the demand for expansion\nof distribution centers, either new or use for vacancy in-fill tenants, but\nproximity to transportation hubs may be a criterion.<\/strong><\/p>\n\n\n\n It has been common for\nretailers to have clauses in their leases making the contract rent just a\nminimum to be moved higher by percentage rents if sales exceed the stated\nminimum level. Given the current retail environment one possible change could\nbe the disappearance of percentage rents across the board. Retailers with\ninternet sales do not need the store to generate more sales.<\/strong><\/p>\n\n\n\n In the past, shopping centers\nand other retail in general were ranked based on tenant quality with those\nhaving the best balance sheets classified as a \u201ccredit tenant\u201d. Years ago,\nmajor retail bankruptcy was unusual. \nHowever, with the use of financial tools like \u201cleveraged buyouts\u201d and financed\ninternal expansion few, if any, are free from bankruptcy risk. The reduction in\ncredit ratings might be expected to impact capitalization rates.<\/strong><\/p>\n\n\n\n CAUSES OF\nRETAIL PROBLEMS: Some Cities, like San Francisco, caused problems by flawed\nland use or zoning policies. San Francisco adopted measures intended to protect\nthe small retailer such as tightly controlling the issuance of permits for\nchain stores in neighborhood commercial districts. Retailers with 11 or more\nstores nationwide were ineligible for permits. While perhaps, arguably rational\nas a protection for \u201cmom and pop\u201d stores this type of solution eliminated an\nentire spectrum of demand for brick and mortar retail space. Similarly, when\nbanks, title companies and restaurants were driving space demand, rules were\nadopted that precluded their expansion. The Planners completely overlooked a\nstudy of the viability of \u201cmom and pop\u201d stores. Retail stores depend on supply\nchains, employees and operating capital as well as business operating acumen\nmost of which the \u201cmom and pop\u201d operators lacked. This was the attraction of\nowning a franchise where the franchisor provided the operator with a business\nmodel that had everything except the operating capital. However, ruling out\nchain stores eliminated franchise operations from the demand group. A global\nchange in buying habits and patterns away from brick and mortar stores to\nshopping on the internet may be the greatest cause of problems affecting retail\nreal estate.<\/strong><\/p>\n\n\n\n DID THE LAND USE AND ZONING\nRESTRICTIONS SOLVE THE IDENTIFIED CONCERNS? Absolutely not In many communities\nacross the Country retail vacancies are a major problem with no viable solution\nin sight. San Francisco, for example, is studying the idea of taxing vacancy\nunder the misguided assumption that landlords are greedy and refusing to rent\ntheir vacant space unless they get the rent they want. Any experienced retail\nleasing agent will confirm that the rent a landlord can command is market\ndriven and only mentally deficient landlords hold out for unrealistic numbers\nafter reasonable exposure of the space to the market. Taxing vacancy will not\ninduce a landlord to rent the space if there is no demand. Problematic vacancy\nis a sign of a shortage of demand.<\/strong><\/p>\n\n\n\n SOLUTIONS:\nThe obvious solution is to figure out how to increase demand. Developing a\ncomprehensive list of neighborhood serving retail uses that do not need to be\nin shopping centers as well as those retailers that can compete in the existing\ncompetitive retail environment (businesses that are not impacted by on-line\nsales) might be a worthwhile exercise. One result of this type of study might\nbe a refocusing of options in terms of identifying potential tenants. A solution\nto that problem may be to revisit the zoning ordinances and land use policies\nwith a goal of eliminating or revising all that impede demand. In other words, stimulate demand through\nincreasing permissible uses. The urgency of this is forcefully demonstrated by\na San Francisco case that was publicized as this paper was being completed: Trader\nJoes, a well-known and respected food market chain applied for a permit to open\na store in a neighborhood that was not serviced by any food stores within close\nproximity. The Board of Supervisors had to override the prohibition of chain\n(formula) stores to allow the application to move forward. Despite this, the\napplication is expected to consume an inordinate amount of time before final\napproval. A potential competing market tenant had reportedly abandoned its\nplans because of the difficulty in obtaining a permit. <\/em>In a forward-looking\nplanning environment this permit application should have received a rapid approval. Instead, the tenant is penalized by having to\nspend unnecessary money because of a very flawed zoning rule.<\/strong><\/p>\n\n\n\n A Planning Department is not equipped to\nmicro-manage uses or to interfere in any way with the law of supply and demand.\nThe market must be the arbiter. The process of granting permits needs to be\nstreamlined and expedited to eliminate the costly delays in permit issuance so\nthat a potential merchant does not need to squander capital pursuing a lengthy\npermit process. Finally, where neighborhood commercial zoning may not permit\nupper floor residential uses the zoning should be changed to permit them as a\nmeans of expanding the surrounding customer base as well as housing supplies. These\nproblems deserve extensive study with a goal of alleviating the problem long\nterm.<\/strong><\/p>\n\n\n\n OFFICE BUILDINGS Office\nproperties have enjoyed an unprecedented rising rent trend to the point where\nonly the largest and most secure firms financially can compete for space. Small tenants and startup ups with limited\ncapital are essentially priced out of the market.<\/strong><\/p>\n\n\n\n The cause of this problem can,\nin San Francisco, be traced by the adoption of rules limiting the issuance of\nnew permits to 950,000 square feet annually and many barriers to entry into the\ndevelopment market. The permit limitation had what, certainly was an unintended\nconsequence, of providing a windfall in rental profits to existing building\nowners. It wasn\u2019t always so good. During the \u201cdot-com bust\u201d and 2007-8 real\nestate recessions there was an office vacancy problem. However today the\npotential problems facing office building are quite different.<\/strong><\/p>\n\n\n\n TECHNOLOGY: The rapid rise of technological advances plus\nhousing shortages combine to induce working from a home office instead of a central\noffice. An escalation of this trend must be expected. Also, business firms are recognizing the\nimpact of office space rental on their annual budgets. Some firms are\nexperimenting with the use of shared offices as opposed to assigned private\noffices. This model was tried many years\nago by major accounting firms who found that much of their staff was, daily,\nworking outside of the central office. The technical ability to remotely \u201ctap\u201d\ninto all needed files greatly reduces\nthe need to be present in the central office in order to work and the use of video\nconferences, via the internet and dial in meetings, substantially reduces the need\nfor face meetings in office conference\nrooms. This change should be expected to\naccelerate as many types of office jobs may be adaptable to this model much in\nthe same manner that firms have outsourced office functions to overseas\ncontractors.<\/strong><\/p>\n\n\n\n ACCESS: The commute distances of today consume valuable\ntravel time and workers who \u201ctele-commute\u201d tend to be more productive. The\nadvantage of working in the central office seems to be more a matter of\nemployee supervision than necessity in many instances. Technology is changing that.<\/strong><\/p>\n\n\n\n FUTURE PROBLEMS: It is possible that the advances in\ntechnology may, in the not too far distant future, reduce the role of office\nbuildings as the workplace in favor of technology dominated models. When that\ntakes place the office building may need to be re-invented.<\/strong><\/p>\n\n\n\n SOLUTION: Future\noffice building design may need to provide an exit path if office uses are no longer\nviable. Such would include an original\ndesign that anticipates a probable conversion from office use to hotel or\nmulti-family residential uses which, in turn, would necessitate zoning that\nanticipates that solution.<\/strong><\/p>\n\n\n\n GLOBALIZATION: The major\ninvestments in real estate are now coming from all over the world. The market for \u201cinvestment grade\u201d real estate\nis now international (global). Real Estate, for the most part should be divided\ninto two categories (investment grade and locally owned). Smaller properties tend to be owned by local\ninvestors and location tends to dominate value. \nHomes priced for the average market are also locally owned. However, super luxury homes tend to be, often,\nmarketable in the international market. Utilizing locally generated\ncapitalization rates for globally marketable properties tends to be a short\nsighted exercise. Rather, the search should be more global than local and\ninclude investor surveys that are nationally or internationally published.<\/strong><\/p>\n\n\n\n The search\nfor supporting data may need to be expanded to a national or international\nscope where that is the market for the property. The definition of a comparable\nsale may need to change. <\/strong><\/p>\n\n\n\n CHANGES TO STUDY: Office\nbuildings or shopping centers that are investment grade properties most\nprobably can\u2019t be valued based on the use of a sales comparison approach mainly\nfor the lack of an adequately sized sample of sales of contemporary, comparable\nproperties from which to draw the appropriate capitalization rate. Rather, the\ncapitalization rate needs to reflective of the market in which the property\nwould sell.<\/strong><\/p>\n\n\n\n Appraisals\nmay have to be much more informative. \nWhile market value is a value at a specific moment in time, appraisals in\nthe future may need to provide the client with information that will permit\njudging whether the concluded value will most probably be durable or subject to\ndownward adjustment in the near future. \nThere is a saying that \u201cperception is 90% of value\u201d and the one\nperception that may be universal is that most humans, when taking financial\nrisk, hate uncertainty. In the future, developing research that provides\ninsight into \u201cuncertainty\u201d may help in reading markets. Fortunately, the advance of technology has all\nmanner of economic data available and it is now more a matter of selecting the\nbest data than developing that data de novo. This means that appraisers may\nexpect to have the availability of excellent sources of reliable data.<\/strong><\/p>\n\n\n\n For\nprofessionals who regularly utilize DCF (Discount Cash Flow) models a daunting\ntask will probably be deciding how, when and if the observed changes might\nimpact the host of assumptions that go into the DCF study. For example, many\npractitioners have used the inflation rate as the rate of change in rent. That may be supportable except when there are\nmajor changes taking place or projecting lease renewal probability may not find\ngood support when demand is not reasonably predictable. The result of DCF\nstudies may not be reliable when any material assumptions are not realistic or\nsupported. This area most likely needs careful examination and revision of\nmethodology where indicated.<\/strong><\/p>\n\n\n\n CONCLUSION: All observed\nproblems suggest many things. First,\nland use policies and zoning must not be etched in stone and will need regular\nreview to make changes that are needed to reflect what the market is telling\nthe observer about the future. A jurist commented (in a case whose name is\nunimportant) something to the effect that \u201cPlanning and zoning are tools for\nuse in planning for the future and should not be used to deny the future.\u201d\nPlanners should recognize that developers are not the enemy and promote \u201ccan\ndo\u201d attitudes instead of \u201ccan\u2019t do\u201d. Planners need to recognize the economic\ncost of protracted permitting processes and make sure that the process is defined\nto be expeditious instead of cumbersome and costly. Planners have to consider that their plans\ncan not control or change the laws of supply and demand as much as that may be\ndesired. If there were a way to limit each family to one child (as China did)\nthey would not need to struggle with the problems of growth. However, that would not be realistic. Lastly,\nPlanners and the political establishment behind them just can\u2019t legislate\ndesign. Great design requires great architects and a bureaucratic attempt to\ncontrol design will fail. Planners must begin with a visit to Cities like Hong\nKong, Singapore, Shanghai, Dubai and Abu Dhabi to figure out what is necessary\nto induce the development of cutting edge and innovative architecture in our\nmarkets. Finally, appraisers may wish to be pro-active in planning for\nperceived changes rather than risking being consumed by them.<\/strong><\/p>\n","protected":false},"excerpt":{"rendered":" Many real estate changes are now taking place, simultaneously, that might, singly or together, represent potential, major \u201cgame changers\u201d (agents of change) to the future of real estate and thus real estate appraisal. The agents of change include, without being … Continue reading