What You Should Know About Real Estate Valuation

Estimating the value of real estate is necessary for a variety of endeavors, including financing, sales listing, investment analysis, property insurance, and taxation. But for most people, determining the asking or purchase price of a piece of real property is the most useful application of real estate valuation. This article will provide an introduction to the basic concepts and methods of real estate valuation, particularly as it pertains to sales.

Key Takeaways

• Valuing real estate is difficult since each property has unique features such as location, lot size, floor plan, and amenities.


• General real estate market concepts like supply and demand in a given region will certainly play into a particular property's overall value.


• Individual properties, however, must be subject to appraisal, using one of several methods to ascertain a fair value.

Real Estate Valuation: What You Should Know

 

Basic Valuation Concepts

Technically speaking, a property's value is defined as the present worth of future benefits arising from the ownership of the property. Unlike many consumer goods that are quickly used, the benefits of real property are generally realized over a long period of time. Therefore, an estimate of a property's value must take into consideration economic and social trends, as well as governmental controls or regulations and environmental conditions that may influence the four elements of value:

• Demand: the desire or need for ownership supported by the financial means to satisfy the desire


• Utility: the ability to satisfy future owners' desires and needs


• Scarcity: the finite supply of competing properties


• Transferability: the ease with which ownership rights are transferred

Value Versus Cost and Price

Value is not necessarily equal to cost or price. Cost refers to actual expenditures – on materials, for example, or labor. Price, on the other hand, is the amount that someone pays for something. While cost and price can affect value, they do not determine value. The sales price of a house might be $150,000, but the value could be significantly higher or lower. For instance, if a new owner finds a serious flaw in the house, such as a faulty foundation, the house's value could be lower than the price.

Market Value

An appraisal is an opinion or estimate regarding the value of a particular property as of a specific date. Appraisal reports are used by businesses, government agencies, individuals, investors, and mortgage companies when making decisions regarding real estate transactions. The goal of an appraisal is to determine a property's market value – the most probable price that the property will bring in a competitive and open market.

Market price, the price at which property actually sells, may not always represent the market value. For example, if a seller is under duress because of the threat of foreclosure or if a private sale is held, the property may sell below its market value.

 

Appraisal Methods

An accurate appraisal depends on the methodical collection of data. Specific data, covering details regarding the particular property, and general data, pertaining to the nation, region, city, and neighborhood wherein the property is located, are collected and analyzed to arrive at a value. Appraisals use three basic approaches to determine a property's value.

Method 1: Sales Comparison Approach

The sales comparison approach is commonly used in valuing single-family homes and land. Sometimes called the market data approach, it is an estimate of value derived by comparing a property with recently sold properties with similar characteristics. These similar properties are referred to as comparables, and to provide a valid comparison, each must:

• Be as similar to the subject property as possible.


• Have been sold within the last year in an open, competitive market


• Have been sold under typical market conditions

At least three or four comparables should be used in the appraisal process. The most important factors to consider when selecting comparables are the size, comparable features, and – perhaps most of all – location, which can have a tremendous effect on a property's market value.

Comparables' Qualities

Since no two properties are exactly alike, adjustments to the comparables' sales prices will be made to account for dissimilar features and other factors that would affect value, including:

• Age and condition of buildings


• Date of sale, if economic changes occur between the date of sale of a comparable and the date of the appraisal.


• Terms and conditions of sale, such as if a property's seller was under duress or if a property was sold between relatives (at a discounted price)


• Location, since similar properties might differ in price from neighborhood to neighborhood


• Physical features, including lot size, landscaping, type and quality of construction, number and type of rooms, square feet of living space, hardwood floors, a garage, kitchen upgrades, a fireplace, a pool, central air, etc.

The market value estimate of the subject property will fall within the range formed by the adjusted sales prices of the comparables. Since some of the adjustments made to the sales prices of the comparables will be more subjective than others, weighted consideration is typically given to those comparables that have the least amount of adjustment.

Method 2: Cost Approach

The cost approach can be used to estimate the value of properties that have been improved by one or more buildings. This method involves separate estimates of value for the building(s) and the land, considering depreciation. The estimates are added together to calculate the value of the entire improved property. The cost approach makes the assumption that a reasonable buyer would not pay more for an existing improved property than the price to buy a comparable lot and construct a comparable building. This approach is useful when the property being appraised is a type that is not frequently sold and does not generate income. Examples include schools, churches, hospitals, and government buildings.

Building costs can be estimated in several ways, including the square-foot method, where the cost per square foot of a recently built comparable is multiplied by the number of square feet in the subject building; the unit-in-place method, where costs are estimated based on the construction cost per unit of measure of the individual building components, including labor and materials; and the quantity-survey method, which estimates the quantities of raw materials that will be needed to replace the subject building, along with the current price of the materials and associated installation costs.

Depreciation

For appraisal purposes, depreciation refers to any condition that negatively affects the value of an improvement to real property and takes into consideration the following:

• Physical deterioration, including curable deterioration, such as painting and roof replacement, and incurable deterioration, such as structural problems


• Functional obsolescence, which refers to physical or design features that are no longer considered desirable by property owners, such as outdated appliances, dated-looking fixtures, or homes with four bedrooms, but only one bath


• Economic obsolescence is caused by factors that are external to the property, such as being located close to a noisy airport or polluting factory.

Methodology

• Estimate the value of the land as if it were vacant and available to be put to its highest and best use using the sales comparison approach since land cannot be depreciated.


• Estimate the current cost of constructing the building(s) and site improvements.


• Estimate the amount of depreciation of the improvements resulting from deterioration, functional obsolescence, or economic obsolescence.


• Deduct the depreciation from the estimated construction costs.


• Add the estimated value of the land to the depreciated cost of the building(s) and site improvements to determine the total property value.

Method 3: Income Capitalization Approach

Often called simply the income approach, this method is based on the relationship between the rate of return an investor requires and the net income that a property produces. It estimates the value of income-producing properties such as apartment complexes, office buildings, and shopping centers. Appraisals using the income capitalization approach can be fairly straightforward when the subject property can be expected to generate future income and when its expenses are predictable and steady.

Direct Capitalization

Appraisers will perform the following steps when using the direct capitalization approach:

Gross Income Multipliers

The gross income multiplier (GIM) method can be used to appraise other properties that are typically not purchased as income properties, but that could be rented, such as one- and two-family homes. The GRM method relates the sales price of a property to its expected rental income. (For related reading, see "4 Ways to Value a Real Estate Rental Property")

For residential properties, the gross monthly income is typically used; for commercial and industrial properties, the gross annual income is used. The gross income multiplier method can be calculated as follows:

Sales Price ÷ Rental Income = Gross Income Multiplier

Recent sales and rental data from at least three similar properties can be used to establish an accurate GIM. The GIM can then be applied to the estimated fair market rental of the subject property to determine its market value, which can be calculated as follows:

Rental Income x GIM = Estimated Market Value

 

The Bottom Line

Accurate real estate valuation is important to mortgage lenders, investors, insurers and buyers, and sellers of real property. While appraisals are generally performed by skilled professionals, anyone involved in a real transaction can benefit from gaining a basic understanding of the different methods of real estate valuation.

 

 

Source: What You Should Know About Real Estate Valuation

https://www.creconsult.net/market-trends/what-you-should-know-about-real-estate-valuation/

Lending Guru Charles Rho Gives Advice on How to Prepare During a Down Market

After 17 years with General Electric Capital, closing on more than $11 billion in transactions, Charles Rho was recruited by CBRE in 2014 to launch a new division for commercial business lending.

Big stuff, but the right man for the job.

Since then, Rho started his own lending firm, VelocitySBA, which has risen to the Top 50 out of 1,600 small business lenders in the United States. His next goal is to put VelocitySBA in the Top 5 nationwide of all small business lenders.

In a recent conversation with Jim Huang, President of eXp Commercial, Rho laid out advice about how any market – even a recession – can be navigated successfully, as long as you are prepared.

Here are the key points Charles Rho made about handling the coming market shift during his talk with Jim Huang:

We Are Entering a Recessionary Period Right Now

“If you look at all the indicators right now with the interest rate movement, inflation, GDP, you will see a general consensus that we are headed for a downturn. Top leaders in banking and other industries acknowledge this is happening. They’re tightening their expenses, starting to lay off employees as well. We've had a number of national banks lay off quite a few workers and really start to get ready for the recession. That's forthcoming,’’ he said.

“My view is that we will probably get into a recessionary period starting (in January 2023) through March. And I believe that the recession will last at a minimum probably 12 to 16 months. So for the next two years, I think we are headed for some tough times,’’ he said.

“That’s why being out in front of your customers, being out in front of your people and directing the organization by making sure you have controls in place will be absolutely critical.”

Understand Your Numbers, Have Control of Expenses and Cash Reserves

“As small business owners, whether you're brokers or you're representing a small business owner who's looking to purchase another small business or looking to purchase real estate, we all need to prepare just as the larger institutions are preparing.

“I'm not advocating that we go out and lay off a bunch of folks, but we do need to understand our numbers. We need to have good control of our expenses, good control of our cash reserves to make sure that we are prepared for the next 12, 18 and 24 months. That may be a bit of a challenging time for all of us.”

GE Capital Taught Rho How To Be Nimble

“While GE is a huge conglomerate, the reason GE was very successful, including GE Capital Businesses, was that each business unit was its own balance sheet. Each business was able to operate like a small business. We were able to react quickly. We were able to pivot in the market based on market conditions. We were able to quickly launch products, and that entrepreneurial spirit was able to propel GE Capital's Businesses to become very specialized and to become No. 1 or No. 2 in their specialty finance area.”

Identify Your Strategic Advantage

Everyone needs a sound business plan when they launch, but Rho said that’s not enough.

“A business plan should be an ongoing process, updated on an annual basis so that you're always projecting out 3-to-5 years. This helps you to align your focus where you know and direct the business to where you need to go. This is what I do on an annual basis. Sometimes we update the business plan once or twice a year if we need to pivot because of a changing environment,’’ he said.

Identifying your strategic advantage is the key to developing your business plan.

“We all have competitors. And we all have to understand who our audience is. What is it that you're selling? And based on that, what is my strategic advantage? That is a key component that I sometimes see is missing from business owners. They don’t understand what their key advantage is and they don't understand who their competition is. That’s how to take a business to the next level. What is my strategic advantage?”

Review Everyone in Your Organization

Rho said ranking every employee based on their experience and skill set is a key part of creating a 3-to-5-year business plan. You have to know what their capacities are, what their potential is. These are the people upon whom your business plan rests. This is your team.

Always Consider Your Economic Climate

Given the projected downturn, Rho said it is critical to understand your profit and loss statement, and to have your cash-flow projections. Rho said he did that for his business, with scenarios that kept revenue “normal” to a worst-case scenario projecting a 50% downturn in revenue.

“You need to go through some case scenarios or assumptions. If there’s a downturn and my revenue falls off by 30%, what does that do to my cash? What if the revenue falls by 50%, how does that impact my cash flow, my income statement?”

Key Factors To Survive a Recession

Be liquid. Preserve cash. Understand your P&L and how your revenues may be impacted. You need to then understand how much cash and liquidity is needed to survive through a recession.

Expense control. If your revenues fall by 30%, are you able to maintain your expenses as it lies today or do you need to trim expenses?

Secure a line of credit. If you own real estate, if you own a business, Rho said you should “immediately secure a line of credit before the real estate devalues further.” Acting swiftly means you can secure credit against today’s values before your business potentially suffers a revenue decline.

Watch out for government stimulus: Depending on how deep the recession may get, the government could mirror its use of the SBA program during the Covid pandemic, when they introduced the CARES Act (Coronavirus Aid, Relief, and Economic Security Act) and PPP loans (Paycheck Protection Program).

Be opportunistic. If you expense control and secure credit, you will be able to be opportunistic and be able to transact on deals that may exist in the market, or create deals in the market.

When Banks See Distressed Portfolios, Tap Into SBA Lenders for Better Terms

Rho said commercial real estate agents should make sure their borrowers or buyers are prepared and ready to go.

“It happens in every recession. Bank lenders pull back from lending because they're concerned about their portfolio. They go into portfolio management mode, making sure their portfolio of loans stay healthy and that loans don't go delinquent,’’ he said.

Look for lenders who will continue to provide SBA financing during the downturn. These tend to be lenders willing to work within the community for more favorable terms.

“If you're financing the acquisition of a business, or you're looking for working capital equipment loans, those are going to be typically done on a 10-year term. Real estate is going to be a 25-year maximum term. What you'll notice if you're used to working with banks, bank loans have a much shorter term,’’ Rho said.

“The advantage of SBA loan is that you have a longer term and that allows the small business owner or the borrower to really reduce the monthly payment so that you can focus more cash flow into the business rather than into the debt payment.’’

Tips For Helping People Secure Loans From SBA Lenders

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  • Look for loans with no balloon, no need for refinancing and no prepayment penalty.
  
  
  
  

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  • SBA lenders look at the strength or weakness of the business owner and their ability to repay the loan. That includes the ability to service the debt and a credit score of 680 or above.
  
  
  
  

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  • Lenders examine a small business owner’s experience and want to see no criminal background, no bankruptcies.
  
  
  
  

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  • A detailed business plan is very important.
  
  
  
  

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  • Post-closing liquidity is necessary to ensure working capital for at least six to 12 months.
  
  
  
  

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  • Commercial real estate agents can direct customers seeking to start new or expand business to a Certified Public Accountant. Demonstrating a financial history via tax returns, personal financial statement, and there's an SBA application form 1919.
  
  
  
  

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  • Contact a volunteer at Score, a service of the U.S. Small Business Administration to help draw up a business plan.
  
  
  
  

“There are individuals at this Score program that mentor, that help write business plans and help secure financing based on the needs of the small business owners. So take a look at these resources. These are available for anyone who are interested in finding out about what all the resources are available through the federal agencies,’’ Rho said.

“There are also state agencies, like Calcap in California, or the Texas Economic Development office. There are resources,’’ Rho said.

Opportunities Exist for Businesses Positioned and Prepared to Play Offense

When real estate agents or business owners realize the market is shifting, Rho said there are plenty of ways to be prepared, like having a strategic plan and knowing what resources are out there.

“I think what's critically important is to really understand where your business is, where your operation resides today and where it needs to go in the next 12, 24 months, and 36 months. Take a look at what the potential downside and the upside can be during a recession. And I will tell all of you guys right now I am expecting a recession,’’ Rho said.

“But there are two ways you can play this, at least as a lending company: Hunker down and play defense, or try to play offense and look for opportunity. That means understanding what your strategy is and what’s your competition.Those who can control their expenses will survive through a recession. And not only will they survive, they will come out stronger and essentially your field of competitors will shrink in a recession.’’

Source: Lending Guru Charles Rho Gives Advice on How to Prepare During a Down Market

https://www.creconsult.net/market-trends/lending-guru-charles-rho-gives-advice-on-how-to-prepare-during-a-down-market/

Cash on Cash Return vs IRR: Understanding the Difference

For commercial real estate investors, having access to as many metrics as possible to provide insight and comparison opportunities is critical. Various metrics are available, including cash-on-cash return and internal rate of return, enabling investors to compare properties more closely when deciding which to choose for investment.

Most investors set their own threshold of what is acceptable to meet their needs or to ensure they hit a certain target before investment. Yet, when investors consider dozens of opportunities each day, it is helpful to have a straightforward metric to help compare properties. These two figures are core components, and knowing the difference between IRR and cash on cash is critical.

What Is Cash on Cash Return (CoC Return)?

The cash-on-cash multiple is a type of rate of return ratio. It provides insight into the total cash earned for a property over the total cash invested into the property. It is based on cash flow before tax within a specific period divided by the equity that’s invested at the end of that period.

Cash on cash return (CoC) is a levered metric or an after-debt metric. By comparison, an unlevered metric is “free and clear” returns. Investors use this metric as a way to assess an investment opportunity.

Cash on Cash Return Formula

The formula for cash on cash return is rather simple:

Annual Net Cash Flow divided by Invested Equity equals Cash on Cash Return
In most cases, this is expressed as a percentage. When it comes to the cash-on-cash calculation, real estate investors typically look at their investment return.

How to Calculate Cash on Cash Return

Applying the formula above, here is an example of how the cash-on-cash works (you can also use a cash-on-cash calculator to help you with this process.)

Bob wants to purchase a multitenant property for $1 million. He puts in $250,000 in equity in the deal. He then finances the $750,000. In this example, the equity investment is $250,000. (Now, this does not include things like closing costs which would also be factored into the equity if paid out of pocket).

After a year, the property provides an annual rental revenue of $120,000. Mortgage payments on the property total $55,000. In addition, Bob invests another $20,000 into the property improvements.

To determine the cash on cash return, the first step is to determine the annual net cash flow for the property. In this situation, the annual cash flow for the property follows this formula:

• Total Gross Revenue minus Total Expenses

In our example, the annual cash flow is $120,000 minus $75,000 or $45,000.

Next, to get the Cash on Cash Return, we need to divide the annual net cash flow by the amount of equity put into the property, in this case, $250,000.

The equation is $45,000 divided by $250,000 equals 18%.

This figure means that the total cash on cash return for that property is 18%. That also means that the investment’s profit for the year will be 18% of the amount of cash that is invested initially.

What Is a Good Cash-on-Cash Return?

Investors typically need to seek out their own answer to this since it is very much dependent on what their needs are and preferences goals are. For some investors, earning 8 to 10% cash on cash return is enough for them. Others do not consider options under 20% cash on cash yield.

Limitations of Cash on Cash Return

There is no doubt that cash on cash return is an important factor to consider, but it has some limitations. For example, it is a simple calculation that measures investment performance. Use it as a starting point when considering investment properties, and then dig deeper into other metrics for more insight. CoC often does not consider things like the length of investment of operating cash flows within a holding period or the reversion cash flow that comes from the sale of the property later.

What Is IRR (Internal Rate of Return)?

Another key figure is the IRR formula. Understanding IRR in real estate can provide more opportunities for you to see the difference in these funding methods. Cash on cash does not account for what investors call the time value of money, but this is where IRR comes into play.

Internal rate of return (IRR) is the interest rate that makes the net present value of all of the property’s cash flow zero. Another way to look at it is the actual annual growth rate calculated by isolating compounding interest’s effects in situations where the investment is more than a year.

Internal Rate of Return Formula

The formula for this metric is complicated and typically not done by hand. Rather, it’s best to utilize Excel or another program for calculating it.

The formula for Calculating IRR

Here is what the formula looks like:

In this,



Ct=Net cash inflow during the period

C0=Total initial investment costs

IRR=The internal rate of return

t=The number of time periods

You can learn more about setting up Excel to calculate this by visiting this link.

What Is a Good Internal Rate of Return?

What is a good IRR? Again, that’s subjective and really depends on the investor’s goals and needs. Most of the time, a 5-year IRR should be around 15% or higher, and sometimes it can be much higher than this.

Limitations of IRR

IRR aims to provide insight into the total return on investment by incorporating compounding interest into the process. However, when IRR is high, that does not always mean that the investment is seeing a cash flow at the current time. That is because this metric also uses the final sale or the existing assets as a component of the formula. That makes it impossible to be the only factor considered during this process.

What’s the Difference Between IRR and Cash on Cash Return?

IRR is the total interest earned on the money the investor puts into the project. The difference between this and CoC is that IRR is focused on the total income earned throughout the investor's complete ownership of the property, whereas CoC provides an annual segment view of the property.

Cash on Cash Return vs. IRR: Which One Should You Use?

IRR is much harder to calculate and typically requires having a significant amount of data about the property at the time of estimating. However, it is worth using both metrics. Often CoC is the first step to weed out less-than-desirable properties. Then, before investment, investors take a closer look at these metrics to provide a more comprehensive review of the investment’s opportunities.

Wrapping Up

What is a good cash-on-cash return? When should you use IRR? These are very important questions.

The key here is that commercial real estate investors should have as many metrics as possible available to them to use to determine which property could be ideal and which meets their very specific needs or goals. It’s not often a question about which one to use but how a property looks using both of these metrics.

 

Source: Cash on Cash Return vs IRR: Understanding the Difference

https://www.creconsult.net/market-trends/cash-on-cash-return-vs-irr-understanding-the-difference/

Chicago Renters Only Make 69% Of The Income Needed To Afford Starter Homes.

The average income of renters in Chicago isn’t quite enough to allow them to afford an entry-level home. And as long as interest rates stay high and inventory is low, that will likely remain the case.

As of October, when interest rates were 7%, the average household income needed to cover a mortgage for a Chicago starter home was $63.4K. But the average income of renters was $43.6K, according to Point2Homes research.

That means Chicago renters make only 69% of the income needed to become first-time homeowners, according to Axios reporting on the study.

Point2Homes data indicates the average cost of a Chicago starter home is $204.7K, effectively pricing out many renters given rising interest rates and shrinking single-family housing stock.

Only 15 of the 50 largest U.S. cities offered average starter homes for less than $200K, the traditional affordability cutoff for first-time homeowners.

Rising mortgage interest rates, high housing prices, and limited inventory make it harder for people to buy their first homes. According to the report, "the modest, bare-bones homes of yesteryear have become the stuff of myths and legends."

About 70% of all new builds were starter homes in the 1940s and 40% in the 1980s, but the percentage had fallen to 7% by 2019, according to Census Bureau figures.

"Renters’ homeownership dreams don’t match the reality in almost any of the large U.S. housing markets," the report's authors said.

Earlier this year, Business Insider reported that first-time home homeowners struggled to afford the typical 20% down payment on a home, which averaged $78.4K based on median home prices when the article was published in March.

 

 

Source: Chicago Renters Only Make 69% Of The Income Needed To Afford Starter Homes

https://www.creconsult.net/market-trends/chicago-renters-only-make-69-of-the-income-needed-to-afford-starter-homes/

2023 eXp Commercial Commercial Real Estate Symposium

REGISTER TODAY

The Commercial Real Estate Symposium will provide junior and senior agents and brokers with valuable insights on topics, including: international opportunities, capital and funding for small businesses in today’s market, how to attract investors, and much more.

Dates: April 25-26, 2023
Start Time: 9 a.m. - 4 p.m. CST
Location: eXp Commercial Campus

We look forward to seeing you in the metaverse!

Important: Please download the virtual eXp Commercial Campus prior to the event, and follow the instructions to login and create your avatar. Feel free to explore the campus before the event begins.

 

+ Add to Google Calendar   + Add to iCalendar

 

Interested in Joining eXp Commercial as a Commercial Real Estate Agent?

Further Info

https://www.creconsult.net/market-trends/2023-exp-commercial-commercial-real-estate-symposium/

Here’s What to Expect in Investment Sales in 2023

Before we welcome 2023, let’s look at 2022 and how the New York City investment sales market performed, where we are now, and where we might be headed in the new year.

Can you believe that the 10-year Treasury one year ago was 1.48 percent? Doesn’t it seem like that was years ago? I think the thing that 2022 will be most remembered for will be inflation, the unprecedented pace of interest rate increases, and the impact these factors had on the commercial real estate lending markets. To say that things are more challenging today is an understatement.

Coming into 2022, we were very optimistic. In the fourth quarter of 2021 in Manhattan, the sales market for properties over $10 million saw $8.5 billion of volume and 89 sales, both quarterly highs going back to 2016 (except the $9.2 billion total in the second quarter of 2019). Interest rates were low, metrics were moving in the right direction, and it seemed like we would be pulling out of an investment sales malaise that began in October of 2015. 

 

For perspective, in 2015, during the cyclical peak, there were $57.5 billion in sales over 484 transactions. The trough was in 2020, with $11.1 billion in sales over 104 transactions. In 2021, those numbers increased to $15.75 billion and 191 transactions. Through the first three quarters of this year, we were on pace for $21.7 billion and 215 transactions, increases over last year of 38 percent and 12 percent, respectively. However, given how increased interest rates have impacted the market, we expect fourth-quarter 2022 results to be well below the yearly trend. The optimism we went into 2022 with is absent from our perspective heading into 2023.

Inflation was tremendous in 2022, but is that a surprise to anyone? How could inflation not be impacted if the federal government pumps trillions of dollars into the economy? Notwithstanding how much you think the war in Ukraine has impacted things, inflation would still be elevated even if the war never happened. Reducing our ability to produce energy and pumping unprecedented amounts of capital into the economy was a cocktail that could result in only one outcome.

At the same time, many economists believe that the Fed has misdiagnosed the labor market. It scared some folks when the Fed announced that interest rates would “continue to increase until the labor market cools.” However, if we look at the number of jobs in the U.S. economy, there are only about 1.2 million more jobs today than there were in 2019. If we had projected where we would be at the end of 2022 back in 2019, expectations would have been that we would have 3 million to 4 million more jobs by now. The labor market is not overheated; it is undersupplied. This is evidenced by the reductions we have seen in the labor participation rate, which is tangibly lower than it was pre-pandemic. Some economists believe we are being treated for a disease we don’t have. So interest rates have risen, and, importantly, they have risen at an unprecedented rate.

In November, the Fed increased interest rates by 75 basis points, the fourth consecutive 75-basis-point increase, after a 50-basis-point increase in March. This unprecedented pace of rate increases was three times faster than the increases we saw during the period from 2004 to 2006. This pace, inexplicably, doesn’t consider that Fed action normally has a many-month lag before the economy is impacted.

For the commercial real estate market, the impact of these increases was not felt until about three months ago. At that point, the commercial mortgage market was tangibly impacted, and borrowing became much more expensive for borrowers. Interestingly, because of this, comparable sales are only starting to become valid for determining value today. Up to now, most closings are occurring based on contracts signed in the old market and do not consider the current financing market. To determine a value today, we rely much more on contract negotiation activity than transactions that have closed.

Current market conditions have highlighted the fact that cap and interest rates are not highly correlated. Most folks believe this is the case, but it is not. Interest rate fluctuations generally predict the direction of cap rates but not the magnitude of those increases. The cap rate versus interest rate relationship over the long term shows that the relationship is not highly correlated. The flow and availability of capital are more impactful on cap rates and more highly correlated over time rather than increases in interest rates. And that flow and availability of capital are most highly correlated to an age-old battle. Markets are a constant battle between fear and greed, and today fear is winning — so cap rates are rising.

As we head into 2023, refinancing risk will be the most-watched market dynamic. Unlike in 2008 and 2009, regulators won’t allow lenders to extend and pretend. So an owner with a $35 million loan on a $50 million asset will be faced with a big decision when the mortgage matures, and the refinancing proceeds available will be $27 million. The first question is, does the owner have the $7 million to put into the property to effectuate the refinancing? If the answer is no, the owner is left with a decision of whether to sell all of or a partial interest in, the property. If they have the money, will they “invest” that fresh capital into the asset? These will be profound decisions for folks with debt maturing.

Concerning product type performance, each sector will have its own drivers of activity, and there are currently more questions than answers. How will return to work play out in the office sector as leverage in the labor market shifts? How will aggregate demand be impacted as flexible working environments ebb and flow? How will consumption patterns impact the demand for space in the industrial market? Within the multifamily sector, will our elected officials change policy to promote the creation of more supply? In the land sales market, will policy impact property values such that owners are incentivized to sell? In the hotel market, we have seen a tangible reduction in the stock as many rooms have been converted to alternative uses. How will market conditions impact travel patterns? And how will the strength of the dollar impact decisions about where people go and for how long?

From a more macro perspective, will rates continue to rise, and if so, how much? Inflation, although still elevated, seems to be slowing. Sectors of the economy such as housing, construction, and manufacturing are also slowing. However, services are still seeing upward pressure on prices. So will the Fed continue to raise rates, or will it pause to let the lag kick in? And will the present yield curve inversion lead to a recession? In 14 of the last 15 times, the yield curve has inverted, and a recession has followed.

Notwithstanding these questions, one thing is certain: If you ask investors when they made the best deals of their careers, you will universally hear that they were made at times like we are in right now and are likely to see as we head into 2023. Investing in real estate takes capital and, most importantly, guts. Which investors will have the intestinal fortitude to dive in when many take a wait-and-see position? Will today's deals be the ones investors look back on fondly, years from now, when they all wish, “If I had only bought more!”

Clearly, there is an uncertainty going into 2023 — at a level we haven’t seen. Rest assured that we will continue to track all of the indicators that will provide insight into how trends will unfold and will continue to share those insights with you on these pages.

Meanwhile, best wishes for a safe, happy and healthy holiday season and a prosperous New Year!

 

Source: Here’s What to Expect in Investment Sales in 2023

https://www.creconsult.net/market-trends/heres-what-to-expect-in-investment-sales-in-2023/

The Dangers of Selling Commercial Property Too Late

The last downturn

cost those who chose to sell commercial property an average of

30.3% of their property value

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Reason #1

Why people sell commercial property too late:

Complacency

 

Complacency is the most dangerous state to ignore.

It’s the moment before the market corrects and values decline. When the market goes through this initial correction, our natural tendency is to be complacent because initial corrections actually look like a cool-off period.

Then we expect the market to pick up again and continue with its growth phase.

But, the market continues to deteriorate and worries creep in as we wonder what is going on. Next, it is normal to say to yourself that your investments are good ones that they’ll ultimately come back.

When the market continues to soften until it seems there is no hope in coming back, that’s the absolute bottom of the market and the worst time to sell.

 

This point of capitulation is one of surrender and of asking how the government could let something like this happen.

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Reason #2

Why people sell commercial property too late:

Ownership and Identity

 

In order to avoid loss, people will overvalue what they own.

That is what Richard Taylor, Daniel Kahneman, and Jack L. Knetsch identified with the Endowment Effect. In fact, Kahneman and Knetsch won the Nobel Peace Prize for their research in this area of behavioral economics.

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It’s normal for people to overvalue what they own.

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In a study with Cornell undergrads, broken into groups and given identical coffee cups, Kahneman and Knetsch told one group to value the cups they owned and the other group to value the cups they would purchase.

They found the undergrads with the coffee cups were unwilling to sell their coffee cups for less than $5.25 while their less fortunate peers were unwilling to pay more than $2.25 to $2.75.

But, it was Carey Morewedge’s research into the Endowment Effect that revealed that it’s not loss aversion that leads to overvaluation, it’s ownership and identity.

Morewedge found that it’s our sense of possession that creates the feeling of an object being mine, which then becomes a part of our identity.

 

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Reason #3

Why people sell commercial property too late:

Loss Aversion

 

Why is it so difficult to sell commercial property in a market decline?

According to Brafman and Brafman, authors of Sway: The Irresistible Pull of Irrational Behavior people will go to great lengths to avoid perceived losses.

What’s more, people also succumb to their will to recover what once was.  They will spend whatever it takes not to lose, be it time, money, or emotional resources.

Imagine watching someone playing craps in Las Vegas. When they are on a roll, taking in their winnings, they race through the growth phase, reaching the peak of the game.

They feel ecstatic.

But what happens when the tide turns and they start to lose?

They enter the complacency stage, call it a short turn of bad luck, and keep playing.  They believe they will return to the top. But their bad luck continues.

By waiting to avoid losses, people hold off and then sell at the wrong time — maximizing their losses.

 

They lose their winnings, keep playing and generate losses. They would rather hold onto the idea of getting back to where they were at almost any cost than realizing their loss and moving on to another opportunity.

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Reason #4

Why people sell commercial property too late:

Self Reliance Time Traps

Time Trap #1: Self-Education

 

People will self educate online because it is free and immediately available. A review of the search term on Google for “commercial real estate trends” returned 152 million results. A search for “commercial real estate trends YouTube” turned up 310 million results!

No doubt, an abundance of free information in the form of market data, blogs, market reports, and online opinions on what’s happening in the market is available.

Time Trap #2: Friends, Family, and Non-Commercial Advisors

 

When we aren’t sure what to do, we often consult friends, family, and non-commercial real estate advisors for input. Unfortunately, these people will not want to be the ones to say sell because it is easier to say no and risk being wrong than to say yes and risk not being right.

Plus, most of these folks will not have the data that you have seen here. These people are more likely to share anecdote based advice like “My friend made a killing in real estate. You should hold on, it will come back.” Remember, people who made this mistake lost in 2008-2010.

Time Trap #3: Hire a Traditional Broker

 

It is easy to find a traditional broker, given that 1 in 164 people in the United States today have a real estate license. According to the National Association of Realtors, there are about 2 million active real estate licensees in the United States.

The problem is that most traditional brokers do not specialize in Commercial Real Estate, Investment Sales and further specialization by property type. 

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Have you thought of selling your property and would like to know what it's worth? Request a valuation for your property below:

Request Valuation

eXp Commercial Chicago Multifamily Brokerage focuses on listing and selling multifamily properties throughout the Chicago Area and Suburbs.

We don’t just market properties; we make a market for each property we represent. Each offering is thoroughly underwritten, aggressively priced, and accompanied by loan quotes to expedite the sales process. We leverage our broad national marketing platform syndicating to the top CRE Listing Sites for maximum exposure combined with an orchestrated competitive bidding process that yields higher sales prices for your property.

 

 

https://www.creconsult.net/market-trends/the-dangers-of-selling-commercial-property-too-late/