Today, we are\ncaught in a worldwide pandemic that has, at least temporarily, locked down most\nof the global economy. Everything is closed and people are staying at\nhome. Obviously, other than shopping for\nnecessities and household items, online, most people are not thinking of \u201cgoing\nshopping\u201d. This should suggest that\nconsumers will not be buying autos or homes as it is usual to postpone major\npurchases when things, including the future are unknown.<\/p>\n\n\n\n
The direct\nresult right now should be expected to be a shutdown of demand for autos and\nhomes. That is just for now and might be\nexpected to have broader effects as businesses have discovered working from\nhome if they hadn\u2019t already discovered it. That along with unemployment could\nmean falling demand for office space and the possibility of missed rent\npayments due to the economic shutdown. \nStores, except essential services are closed. That means that save for online sales retail\nmerchants have no customer foot traffic and minimal sales by comparison to more\nnormal times. Thus, there is danger that\nmany retail businesses may not make it through this crisis. Even when the\ncrisis ends there may not be a rapid resurgence of demand for cruise ship\nbookings or hotel occupancy for other than mandatory travel. People emerging from this should be expected\nto defer any travel until THEY feel comfortable that any appearance of normalcy\nis for real and sustainable and not just a \u201cdead cat\u201d bounce.<\/p>\n\n\n\n
These concerns\nand hundreds more should tell us that no\nreal estate professional has any more than a \u201cgut feeling\u201d as to the worth of\nany property. There is no current data to review and no recognizable demand to\nstudy. Often, we are able to draw from past experience to develop a view of the\nfuture but the present situation is like nothing else we have ever experienced. The only lessons seem to be that eventually\nthings turn around. But the missing data\npoint is \u201cWHEN\u201d.<\/p>\n\n\n\n
To provide a\nhistoric backdrop for the analysis some history may be relevant. In 1979 the\nreal estate economy faced a major change when the Federal Reserve, in a\nmidnight Saturday night meeting adopted a very major increase in the interest\nrates that saw mortgage interest rise above 15% or more in some cases. From\n1990 to 1997 there was a major real estate recession attributable to the S\n& L\u2019s, where one culprit was the practice of brokered deposits bringing in\nto the industry monumental transfers of cash to secure the bank account\ninsurance unavailable in a current bank because of the limit insured. The S &\nL\u2019s had to put that money to work resulting in a competitive lending\nenvironment where many safeguards were bypassed. In 2000 – 2001 \u201cDot.com\u201d bust and the Twin\nTowers attack sent negative shockwaves through the U. S. economy. The only real thing that each of these events\nseems to have had in common was the causing of a major disconnect between\neconomic data points before and after the event. One way to think about it is\nthe mindset one would anticipate when a World War (like WWII) starts. The\ndifference between economic data on December 5th<\/sup>, 1941 and December\n8, 1941 (the firs business day after the Pearl Harbor attack) was incalculable\nbecause no data existed upon which to extrapolate forecasts. The first two\nevents were national events while the third was international. However, in the case of WWI, Europe had been\ninvolved since 1939 and Asia had been un upheaval long before that. By contrast the current pandemic is an\ninternational event that spread rapidly and uncontrollably from Asia to America\nto Europe and the world in a matter of a month or so. None of our nation\u2019s\nprevious experiences provide anything that can be looked to for guidance. It\nmust be expected that it will take substantial time for enough new, current data\nto develop before analysts will have a reliable approach to forecasts. The\nuncomfortable truth is that right now absolutely no one has any reliable basis\nfor determining the current value of any piece of real estate. The market value\nof real estate, as measured by appraisers, is its value as of a DATE CERTAIN. Appraisers can still measure value as of a\ndate before the knowledge of the current crisis became public information but\nnot as of a date after that. The only\ndiscussion that might be currently valid is a discussion of what is possible or\nprobable and why that is so. <\/p>\n\n\n\n Addressing the\nsingle-family home market first, seems to be a logical starting point. But,\nfirst let\u2019s take a tangent and discuss what must be concerning to many\nhomeowners. Should I sell now to try to protect my profits? The best answer is\nNO. Any negative impact of the COVID-19has already been built into the market\nand represents the worst shock to value. \nAnticipate that markets often overreact to negative news. Unless it is mandatory to sell now for\nreasons like a mandated move, it would be a better bet to wait until this\ncrisis is over before contemplating sale. \nAnd, if a home is listed for sale right now, consideration mightd be\ngiven to taking it off the market. Overexposing a property (keeping it on the\nmarket) when there is no activity) may ultimately put downward pressure on\nprices. <\/p>\n\n\n\n During periods\nof market disruption, speculators make up whatever demand there is, and the\nspeculator hopes to buy at a bargain price anticipating a big re-sale profit\nwhen the market improves, which it eventually will. Panic selling or selling to\nlow speculative offers is not a recommended course of action unless there is no\nother alternative. But, if inability to make mortgage payments is the main\nproblem, rational thinking would dictate that the government would initiate\nsome form of payment suspension which would suggest waiting before taking any\naction. If there is no safety-net\nprovided (which would be illogical to assume), the first step might be to\ncontact the mortgage lender and try to enter into a \u201cworkout agreement\u2019 under\nwhich the lender agrees to modify payment terms that will avoid the necessity\nof foreclosure. If lenders learned\nnothing else, they collectively may have learned that foreclosure is not necessarily\na useful or sensible problem-solving tool, on a macro basis, unless the lender\nviews the debt as uncollectable in any form. Lenders might wish to consider the\nforeclosure remedy on a case by case basis rather than an applicable policy\nbasis. Lenders would generally be better off with a \u201cworkout agreement\u201d that\navoids putting a loan into default and triggering foreclosure. Widespread\nforeclosures would only lead to an increase of \u201ctroubled\u201d property on the market\nrather than a step in resolving the economic crisis. <\/p>\n\n\n\n But, none of\nthis discussion addresses the question of the current value of the single-family\nresidence. Value in the single family market is primarily dependent on a\nreasonable sample of current sales of comparable properties and no dependable\nsales data can be expected to exist until the market returns to a somewhat\nactive status. That could take some time. \nFirst, second homes will be slower to recover for obvious reasons, thus\nthe date of their recovery will be further into the future. The recovery of\nsales of primary homes will depend on a recovery in the job market to provide\npotential buyers not only willing to buy but, most importantly, ready to buy.\nAs of today there is no basis for forecasting when the employment market will\nrecover sufficiently to induce real demand. Optimism that the market will\nimprove is not misplaced but lacking a reliable time horizon as to when that\nwill happen is a necessary part of any forecast. One can only hope that the\ngovernment will unleash a massive infrastructure repair and building initiative\nto very rapidly provide millions of jobs for the unemployed. If that takes\nplace quickly the \u201clight at the end of the tunnel\u201d will be much brighter and\nmay help one see the timing of a sustained recovery. But the real bottom line\nis that TODAY no one has any reliable basis for determining what any single-family\nhome or condo might be worth today or by a future foreseeable date.<\/p>\n\n\n\n The next property\ncategory is the multi-family property market (apartments). With millions of\nunemployed the population size exerting real demand on rental apartments is\ngreatly diminished. This fact should suggest that landlords try to develop\nanti-vacancy strategies because the replacement renter group should be expected\nto have significantly moderated. Anti-vacancy strategies would mean some form\nof \u201crental payment workout\u201d rather than eviction for non-payment if not already\nin place by law. But, with the current rising unemployment there is no\nreasonable basis for projecting rent increases or the stable amount of vacancy\nin the future. The value of multi-family\nproperty is absolutely a function of first measuring \u201cstabilized rent\u201d then\n\u201cstabilized occupancy\u201d and then a reliable forecast of operating expenses under\ncurrent market conditions. As of right now there is no reliable basis for\ndeveloping future income projections without which value becomes a guessing\ngame until data is available to support projections. The biggest problem for\nlandlords is not knowing how long the problem will last<\/p>\n\n\n\n The best advice\nfor owners of multi-family properties is to have a strategy for maintaining the\nhighest occupancy rates possible at whatever rent level appears to induce\nstrong demand. This means avoiding\neviction by providing \u2018workout agreements\u201d to tenants which may well include\ntemporary or long-term rent reductions. \nThe worst strategy would be one where the tenant is kept guessing about\ntheir future in their home. In times of\nuncertainty all renters, and particularly those who are financially vulnerable,\nare anxious about their futures. That understanding is essential.<\/p>\n\n\n\n The sales of\nmulti-family properties have, up to the virus, been propelled by the excellent\npast performance of sustained high occupancy and regular rent increases with\nvery low capitalization rates being the norm. \nFuture occupancy levels and rent levels are not a \u201cgiven\u201d. The continuance of low capitalization rates\nmay not a rational assumption because some major fallout must be expected as a\nresult of the elevated risk inherent in the state of current economic\ndisruption. The really good news is that the housing supply, before the crisis,\nwas well below the level of demand and, if nothing else, the present crisis could\nretard any major new housing initiatives for a while. Thus, the excess of demand over supply should\npersist into the recovery phase. The only real question for multi-family properties\nis whether capitalization rates will remain low enough to support pre-crisis\nlevels. Who knows? But it would seem to be a better bet that the answer will be\nNO if only because the present economic disruption might be expected to shake\ndown to all levels of the economy.<\/p>\n\n\n\n Brick and\nmortar retail properties were having trouble before the current crisis arrived\nand has only been handed a tsunami of new problems to hurt demand. Tenants who\nwere already having problems and many who weren\u2019t should be expected to be\nforced into bankruptcy if landlords fail to take major initiative steps to\navoid such action. An occupied retail\nspace, where the tenant is likely to remain in business, when the crisis ends,\nwould be preferable to a vacant space. It is axiomatic that a retailer with no\non-site sales will not be able to generate cash flow with which to pay rent.\nThe notification of Cheesecake Factory, to all of it landlords, that they would\nnot be paying rent on April 1st<\/sup> was probably just the first sign of\nwhat may become the norm. Internet\nretail sales do not need a brick and mortar store. Retailers should be expected\nto develop strategies for marketing and achieving higher volumes by internet\nsales and if they didn\u2019t already know it, have found out how to increase those\nsales. With internet sales eliminating the need for a store visit retail\nproperty owner might anticipate a difficult period ahead while trying to\nre-invent themselves. The near-term outlook for retail properties and retail\ncapitalization rates does not appear to be terrific. Landlords have discovered that even the\nstrongest retailer, in financial terms, is not exempt from a serious downturn\nand loss of ability to make timely rent payments. Retail properties viewed as\nrelatively risk free have been exposed to risk and that can develop into a\nlowering of confidence. Today, no one really knows, or can support with data,\nthe probable level of a property value or its anticipated performance in the\ninvestment market. Until unemployment problems are resolved there will be no\ndata based upon which to forecast the levels of spending. Another probable\nimpact may be a postponement of new projects as the first focus will probably\nbe the \u201cin-filling\u201d of vacant space. But, the signs to look for will be a\nresurgence of employment and increased buyer demand for goods. <\/p>\n\n\n\n Office\nbuildings are occupied by businesses many of which are struggling. Law firms, as an example, have litigation\npractices that are inactive due to court shutdowns. Mergers and Acquisitions should be expected\nto go on the back burner for a while, medical offices are seeing patients on an\nemergency basis, realtors are experiencing a lack of buyer and leasing\nactivity. In short, the users of office\nspace are, because of economic circumstances, may be facing reduced\nincome. And, many firms have found,\nduring the present crisis that working from home is a viable alternative to\nworking from the central office. This\nconsideration suggests that businesses might be expected to re-evaluate their\nneed and use for office space going forward. \nIt is much to early to tell what the office sector might look like when\nit emerges from this crisis. <\/p>\n\n\n\n The travel\nsector of the economy has been seriously impacted by negativity. Leaving out the airline and cruise industries\nas separate problems, hotels depend on travel which depends on both business\nand pleasure to generate demand for rooms. Now, travel restrictions put in\nplace mean that no demand for room occupancy exists, almost worldwide. The business\ngenerated demand might be expected to regenerate when the crisis has\npassed. However, depending on the\nemployment picture, vacation travel should probably be expected to take longer\nto recover. What these considerations suggest is that the hotel\/convention segments\nof the economy should be expected to experience near term problems even after\nthe crisis is over. The question that should be going through the minds of\ntravel dependent real estate owners is whether the present \u201cshutdown\u201d will\nteach business new tricks for meeting without travel. During these times businesses\nare still holding business meetings but are doing so via tele-conferencing or\nsimilar methods. Conventions are not as\nadaptable to \u201cvirtual\u201d means and should be expected to be a force but one that\nmay take longer to re-emerge due to the lengthy planning process.<\/p>\n\n\n\n Light\nindustrial (warehouse) space, as a separate investment category, may not face\nthe same adversity as other property types. \nAn increase in internet purchasing should increase the demand for\nwarehouse spaces from which to ship purchases. \nThis may be good for that market sector, but it is much too soon to tell.<\/p>\n\n\n\n During the\ncrisis period, fast food businesses, whether freestanding or in retail spaces\nare possible beneficiaries of the \u201csheltering in place\u201d economies as they shift\nto sanitary \u201ctake out\u201d service and serve a wide population looking for a way to\ndine out by dining in. <\/p>\n\n\n\n The traditional\nappraisal process usually includes considering the use of the Cost Approach,\nThe Sales Comparison Approach and the Income Approach. The Cost Approach is probably not close to\nbeing reliable for the primary reason that there is no currently relevant data available\nfor estimating the land value component of the approach. The Sales Comparison Approach is not useful\nuntil a sufficient sample of current sales is available for study to guide a\nvalue conclusion by that method. Past\nsales that took place under totally different economic conditions are not a\nguide to the present or future market conditions and, because of the changed\neconomy, cannot be reliably \u201cadjusted\u201d to reflect the present. The Income\nApproach depends on a supportable conclusion as to the sustainable market rent\nand occupancy level of rental space, which, now lacks any viable data\ninput. So, the inescapable conclusion is\nthat the traditional tools for valuing property all currently have fatal flaws\nin terms of reliability.<\/p>\n\n\n\n The valuation\nof large investment properties most often involve a discounted cash flow (DCF)\nanalysis which is very complex but most importantly requires key assumptions as\nto many of the study inputs. The\nreliability of the inputs used is currently without available support absent\nsignificant data availability. Thus, the\nDCF model is of questionable reliability.<\/p>\n\n\n\n At the end of\nthe day, appraisers will still be called on to provide appraisals. However, a strict reading of the applicable\nstandards may well mandate that the appraiser, in rendering a value opinion,\nwill need to discuss the level of reliability applicable to the conclusion\nkeeping in mind that the opinion applies as of a date specific not just any\ndate. It is not a violation of standards\nto qualify conclusions as being based on the best available information while\ndisclosing that the information is of limited reliability and why. <\/p>\n\n\n\n Right now, as\nof today, no one really knows where the $ value of any real estate really\nis. It is possible to forecast, but to\ndo that assumptions must be made and without a solid basis for the assumptions\nthe result becomes a GUESS. An educated guess may be the best available result,\nbut the conclusion must clearly disclose that and not be presented as\nconclusive. Moreover, in an economy facing a high risk of recession of unknown\nlength or severity mandates that the \u201ceducated guess\u201d is logically reasoned and\nnot just based on wishful thinking. <\/p>\n\n\n\n There is an old\nsaying \u201ca smart person knows what they do not know\u201d and that should describe\nthe vast majority of people today. We just can\u2019t know, with a measurable level\nof certainty what the post crisis value of any individual property is really\nworth in terms of established valuation standards. What this paper addresses\nare not intended to point to value or how to measure it. The most important consideration when faced\nwith \u201cknowing what your do not know\u201d is to consider the myriad of questions\nthat need answers before \u201cnot knowing\u201d can convert to knowing\u201d.<\/p>\n\n\n\n \u00a9 Lloyd Hanford April 2020<\/p>\n\n\n\n www.lloydhanford.com<\/p>\n","protected":false},"excerpt":{"rendered":" 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 … Continue reading