Much is now hyped in the real estate press about the renewed life of retail bricks and mortar.
In-store sales are enhanced by such ethereal concepts as “experiential retailing” offering a sense of community and collaboration, all branded (and personally curated no less). Buzz words are everywhere, but any actual contribution to real property value is even thinner ether. These are business marketing concepts which are unrelated to real property value.
The addition of personalization and specialized branding to the retail business models in industries such as fashion may be spectacular, and those catchy buzzwords get the message out. But the site improvements and physical components of a retail building serve both the existing tenant and next tenant, with impartiality.
What is the significance of this, particularly to less experienced commercial assessment professionals? The existence of your newly favorite retailer in the shopping center does not add to the real estate bottom line; that bump in select retail stocks does not increase market value. Nothing personal… it’s just about the rent.
Today’s assignment for Commercial Real Property Analyst Dixie Phair is an apartment property. Dixie always uses an income model (and you surely should too!) to aid in apartment valuation. In this case, her model is especially helpful because it allows her to test under three valuation scenarios.
The particular model used by Any Municipality County stratifies multifamily property by Gross Rent Multiplier (GRM) and Overall Capitalization Rate (OAR) as follows:
GRM for 2 to 4 unit properties
GRM for 5 to 19 unit properties
OAR for 20 to 59 unit properties
OAR for 60+ unit properties
Never at a loss for relating almost anything to income-based analysis for real property, I find a ready analogy in the renovation of an older car.
Just consider the rebuilding of an auto transmission as an example of how important it is that all components work together:
| Tranny Components
|| Income Value Components
| Clutch facing
|| Rent rate
| Gear roller bearings
|| Expense ratio
|| Overall cap rate
Your success in the auto renovation will be limited at best if you do only a partial rebuild of transmission components, like switching out only a clutch facing when the flywheel and bearings are also worn. You may get instant gear engagement, but the ride will suffer greatly from related noise and vibration.
If you try to skimp on updating an older income model for property valuation, much the same will be true. Update only the rental rate, and the outcome won’t be an accurate value because the outdated components of vacancy, expenses, and cap rate remain.
The examples are similar, but there’s one main difference between them… with a partial renovation, the car might still get you from point A to B, albeit with some annoyance. But that partially updated property model simply won’t get you to market value.
Recent history tells us that real property values almost never stand still. In many markets, values broadly tanked beginning in 2008 until a slow climb back up began in about 2011.
But what if values did stand still, even as population, employment and credit availability fluctuated? That would only happen if there somehow was a fortuitous synergy of precisely offsetting economic and social events. Humans creating policy will never effect that scenario.
Real property values don’t stand still for long, and the fluctuations are not consistent or linear. Market changes impact different market segments in different ways: values for office and industrial product can increase while multifamily and retail decline… quickly, slowly, or erratically.
Keeping up with fluctuating property economics is a real challenge for assessors of commercial property. Don’t short change your market model. Maintenance of accurate values means watching local trends in:
- Tenant Improvements
- Overall Cap Rates
All of these elements (not just rents) must be sensitized to type, subtype, tenant design, size, quality, and location.
Since available sales are rarely sufficient for commercial stratification, income modeling is critical. If you craft your own models, they must reflect local reality from the start and be updated annually. This is the only way to stay current with changes in your market.
Except for some industrial property types such as manufacturing, it usually pays to develop to reasonably current design standards; changing social needs have also altered the viability of some designs.
For example, many U.S. cities still sport those cantilevered federal buildings with multiple exterior stairs that now defy easy access due to increased security measures. Just try to use those stairs!
In perhaps the best example, enclosed malls across the country lucky enough to still have anchor tenants are desperately trying to renegotiate lease terms for those anchors. Not only do these older enclosed malls have outdated designs, functionally obsolete elements, inefficient layouts, and below standard (expensive to correct) components, but the photo above shows a different kind of awkward… an uncomfortable, uneasy, and problematic situation that is the reality in too many towns. Continue reading
Dixie Phair knows that few enjoy confrontation or disagreement, and most will strive to avoid it. But in her capacity as Commercial Real Property Analyst for Any Municipality County for almost five years, she also has learned that disagreements must be squarely addressed in the interest of equity.
She recognized early in her position that repeated appeal hearing attendance increased her confidence, allowing her to focus calmly on the facts instead of on the possible discord. For this reason she makes it a practice to select a commercial staff member to accompany her in hearings to observe and similarly bolster their comfort level.
Since Dixie always prepares an outline of the County’s position (formatted in bullet points for presentation to both the Appellant and the Hearing Officer), she is sure to review the outline with her staff. Like a tutor, she makes time to work individually with the staff member accompanying her to the appeal, to ensure he or she understands it and works through the math behind it.
After a few hearings, she then tasks the staff member with preparing the outlines. At this point, most of her students start to lose their reticence and begin to take on at least some role in the proceedings.
Dixie’s commercial staff is learning an important lesson… the appellant can be right as well as wrong; the speed of figuring that out corresponds to each Assessment Professional’s experience and comfort level with the process.
One of the biggest trends in office space marketing is the co-working or shared space concept, offering a flexible menu of space and services in an established office environment. These spaces are typically leased in bulk, generally to a marketer who designs and builds it out. The goal is to offer a professional setting tailored to meet the exact desires of their targeted clientele.
While pricing for the selected space and services is often a bargain for a small tenant with limited needs, it is higher in the aggregate for the bulk space if the concept achieves good occupancy.
Achieving good occupancy is a business related effort: smart design, management, and marketing skills must be leveraged in order to create margin for the shared space operator.
But is that higher pricing reflective of the real estate? No!
The answer will remain “no” until the shared space design is indelibly woven into purpose built construction and this trend becomes an established niche in office development and management. This means we use the bulk lease rates to value these properties for now, but stay tuned – this trend is growing fast!
As someone who has been involved in many appeal hearings, I’ve witnessed firsthand how much valuable time is lost because of timing. What do I mean by time lost because of timing? Read on.
The issue (which shouldn’t even be one) is incorrect citing of published information used in support of an overall cap rate, appropriate rent, vacancy rate, or other market indicator. This published information, typically in the form of surveys, is often cited in valuations as of a certain date.
However, for assessment purposes, valuation is assumed to be “as of” the tax date. Thus, intrinsic in that assumption is use of data available as of that date. If quarterly surveys are cited, they should only be those released (available) as of the specific tax date. For example, if the tax date is January 1, 2018… publications from 4th quarter 2017 (and earlier) are appropriate for comparison; publications from 1st quarter 2018 do not apply.
Hindsight is great, but use of surveys released a month or two after the tax date leads to confusion and wasted time in the hearing room. Take a moment to review the published date on the cited supporting data; the only relevant surveys are those that were available as of the specific tax date.
Valuation is as of a distinct point in time, not after data arrival. In a fast moving market, this makes a difference.
The appeals process reminds us to focus on equity for the taxpayer. Though frivolous appeals happen all too often, appeals certainly can be justified. Since my role in this industry is to provide guidance in income based valuation, a policy I find useful is to make certain the all important market rental rates agree with three principles:
Submarket Specific Rent
The rent estimate must relate exactly to the subject location, type, and subtype. For example, the rent for a medical office on a hospital campus may not relate well to rents applicable for off-campus medical properties.
Aging of Comparable Contracts
Consider the age of the contracts provided as comparables. When were the comparable leases executed in relation to the assessment date of value? If very different, is there a supportable basis for adjustment?
Achievable Rent Versus Asking Rent
Comparable aging (see above) can sure help here, but if not, definitely research achievable rents. This takes diligence: talk to active brokers in your area, particularly those local brokers knowledgable in the specific property type you are working with. Give them examples of similar buildings and ask what is achievable in the local market.
Again, while there are those unfortunate tax appeals which rob jurisdictional time and expose appellants to only contingent expense, as everyone knows, some appeals are wholly justified.
Equity isn’t always easy.
The title of this post does not have a typo. The word “ruck” has several meanings, most having to do with typical gatherings of people or things. In rugby, it refers to a scramble for the ball on the ground. In the assessment world, it accurately describes the last minute hustle to find supportive data for an appeal hearing.
Before you head into the hearing, pick up the phone. Call the two brokers in your market; the two most active brokers in the type of property under appeal.
For this example, we’ll assume an office property is under appeal. Here are helpful questions to ask the brokers:
Are there any recent sales, or pending sales, you are able to disclose?
Are there any recent leases, or pending leases, you can relate?
Have typical office expenses recently increased or decreased?
Has anything happened recently in the local market (or nationally) to impact supply and demand?
Chances are you’ve already done your homework well, but it never hurts to demonstrate the most up-to-date market knowledge. This may elevate you from the ruck.