Magazine article Journal of Property Management

Growth of Bulk-Sale Market Spurs New Valuation Model

Magazine article Journal of Property Management

Growth of Bulk-Sale Market Spurs New Valuation Model

Article excerpt

Today's commercial real estate market is reminiscent of "The Little Engine that Could." Tenant by tenant, the market is struggling up the hill of stabilization and value. If and when the train reaches the top, it will look back into a valley of vacancy and over-leveraging and see not one but two real estate markets left in the wake of the recession.

Of course, there will be the traditional market, but also the "bulk-sale" market, created as the government and private sector financial institutions disposed of their mammoth inventories of non-performing commercial mortgages.

Since 1991, almost $50 billion has been dumped into this new market, forcing most owners to guess the volatile value of their assets. Appraisers could not keep up, and appraisals did not seem propriate for bulk sales anyway. So the Resolution Trust Corporation (RTC) took the bold step of developing a new valuation methodology suited to the bulk-sale market: derived investment value (DIV).

Conventional appraisals measure value assuming a willing buyer and seller and a reasonable period of time to make a sale. Appraisals also typically assume that the property is sold separately, or in a small group, but not in a large portfolio.

DIV, on the other hand, values large portfolios of properties or loans, sold on an accelerated or distressed basis. The differences in these valuation approaches are essential for owners and managers to understand when they analyze hold versus sell strategies.

The appraisal approach

Traditional valuation conclusions are typically based on three separate approaches: market comparables, replacement cost, and discounted cash flow. To this end, an appraisal will include an explanation of the current and anticipated supply and demand for the subject property as well as an in-depth review of competing properties.

The appraiser will also analyze the property's revenues on a lease-by-lease basis and verify each operating and capital expense item. Operating cash flows will be capitalized and discounted using rates developed specifically for the subject property. The ultimate reconciliation of the three values serves as a proof of the results.

The DIV approach

Such a property-specific analysis would be impossible when valuing a portfolio of assets that may number in the hundreds. Alternatively, the DIV methodology, described in Appendix H of the RTC's Asset Due Diligence Manual for Income Producing Properties and Land, provides a more "quick and dirty" approach.

In fact, the introduction to Appendix H states that "the methodology and procedures are not intended to and do not comply with the Uniform Standards of Professional Appraisal Practice (USPAP) for preparation of market value appraisals as defined by the Appraisal Standards Board of the Appraisal Foundation."

The differences between appraisal and DIV are easy to recognize. First, DIV focuses only on discounted cash flows and basically ignores the sales comparable approach, except in the valuation of certain land parcels. Similarly, the cost approach is not considered.

Second, while DIV includes property-specific analysis of rental rates and occupancy (occasionally on a lease-by-lease basis for larger properties), it also provides many global assumptions to be used for all assets in the portfolio. These assumptions include rental and expense growth rates, tenant renewal probabilities, downtime between leases, and replacement reserves.

These global assumptions are provided in Appendix H recognizing that they may not be appropriate in the context of the entire portfolio. Accordingly, the DIV computed for a particular asset is not meaningful--only the aggregate of the DIVs computed for all the assets in a portfolio may provide an indication of the value of the portfolio in the bulk-sale market.

The most important global assumptions are the capitalization and discount rates, which clearly reflect the often distressed nature of the sale and the higher returns required by bulk-sale investors. …

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