When Market Conditions and Buyers Expectations Differ

[Terrel L. Shields]

I have some good comps considering small strip malls are not all that common and popular. I am doing a 15,300 SF U shaped mall, good Hwy location in a 50k town. I have a similar comp that is same kind of construction similar location about a mile away and it sold for about $100/SF. Couple other sales somewhat newer sold about $120/SF. The sales and cost came is close but the income is much lower.

The rents are $4-6 less than advertised local rents, but many of these strip centers have a lot of vacant spots. The manager and the owner (deceased) chose to go with higher occupancy rates and lower rents. Single net lease, but renter pays for any ungrades in the store. Some renters go back to 2003.

The dilemma I face is the trade off. Market rents are higher, so is vacancy. And under the market conditions, small retail shops are not performing well. The complex has a dry cleaners, Mexican cafe, a nail salon , a stylist, a computer repair, another stylist, and a sports card and toy store, plus a small ethnic food store. Even bumping up rents substantially is likely to create vacancy, or renters demanding new carpet, or other upgrades.

The newer stores (post 2014 or so) have much higher rents but all of them seem to be churning a lot of renters. But buyers seem eager to pay well above what income would say they should want to pay. I am not seeing the economics of this. Talking with an 82 year-old property manager laid out the owner's philosophy and also told me of similar strip centers where vacancy was high. I had to sort of do a drive by estimate of vacancy, but he is right, there are a lot of vacant buildings and for rent signs around. I don't think this reflects the local economy which is booming, rather seems to reflect the competition from on line services. Only the sort of businesses found in this center seem to be thriving. Personal care products, niche products, or restaurants which have mostly recovered from the pandemic.

At this point, I will use market rents that are somewhat higher than the actual ($7/SF) but much less than the advertised $14-18/SF properties. Only a DG or similar high volume business is paying that much in this town. Any suggestions?

 

[Zephyr999]

What about looking at a rent differential and apply to all approaches conclusions to get to as-is value.

 

[Terrel L. Shields]

What about looking at a rent differential and apply to all approaches conclusions to get to as-is value.

I am applying higher rents than economic, I cannot justify even more rents under market conditions, but buyers seem eager to buy almost anything. The buyers are investors, often from out of state. I am thinking they believe they can pretty much double rent without consequences.

 

[J Grant]

I have some good comps considering small strip malls are not all that common and popular. I am doing a 15,300 SF U shaped mall, good Hwy location in a 50k town. I have a similar comp that is same kind of construction similar location about a mile away and it sold for about $100/SF. Couple other sales somewhat newer sold about $120/SF. The sales and cost came is close but the income is much lower.

The rents are $4-6 less than advertised local rents, but many of these strip centers have a lot of vacant spots. The manager and the owner (deceased) chose to go with higher occupancy rates and lower rents. Single net lease, but renter pays for any ungrades in the store. Some renters go back to 2003.

The dilemma I face is the trade off. Market rents are higher, so is vacancy. And under the market conditions, small retail shops are not performing well. The complex has a dry cleaners, Mexican cafe, a nail salon , a stylist, a computer repair, another stylist, and a sports card and toy store, plus a small ethnic food store. Even bumping up rents substantially is likely to create vacancy, or renters demanding new carpet, or other upgrades.

The newer stores (post 2014 or so) have much higher rents but all of them seem to be churning a lot of renters. But buyers seem eager to pay well above what income would say they should want to pay. I am not seeing the economics of this. Talking with an 82 year-old property manager laid out the owner's philosophy and also told me of similar strip centers where vacancy was high. I had to sort of do a drive by estimate of vacancy, but he is right, there are a lot of vacant buildings and for rent signs around. I don't think this reflects the local economy which is booming, rather seems to reflect the competition from on line services. Only the sort of businesses found in this center seem to be thriving. Personal care products, niche products, or restaurants which have mostly recovered from the pandemic.

At this point, I will use market rents that are somewhat higher than the actual ($7/SF) but much less than the advertised $14-18/SF properties. Only a DG or similar high volume business is paying that much in this town. Any suggestions?

I don;t do commercial property but will give my perspective

We are using the MV definition of typically motivated buyers...what is the motivation of the typical buyers purchasing these properties> If the rents are low with income /cash flow and the trend is for retail stores to be doing poorly..are the buyers aware of it? Sold rosy figures from RE agents? Or are they buying these shopping centers to hold and sell later, or hope the area booms, or to rezone/ rebuild for residential or other uses?

Are the buyers ignorant about the poor rental performance? The MV definition references well-advised or well-informed buyers.

 

[J Grant]

I am applying higher rents than economic, I cannot justify even more rents under market conditions, but buyers seem eager to buy almost anything. The buyers are investors, often from out of state. I am thinking they believe they can pretty much double rent without consequences.
View attachment 88157

Then, they do not meet the MV definition of a well-informed and well-advised buyer.

This would explain why your opinion of MV is below whatever target $ refi direction or sale contract $ amount is in play for the subject. Explain that the majority of buyers are from out of state and appear to be overestimating the rental income or difficulty of finding tenants to fill vacancies at areas with higher rents.

 

[Zephyr999]

I am applying higher rents than economic, I cannot justify even more rents under market conditions, but buyers seem eager to buy almost anything. The buyers are investors, often from out of state. I am thinking they believe they can pretty much double rent without consequences.
View attachment 88157

That's what I was thinking was happening...being told there's an upside on rent growth that seems higher reward for the risk.

 

[Terrel L. Shields]

Are the buyers ignorant about the poor rental performance?

Well, investors should know to study their market. As for "poor" performance. If you have a renter who remains in place for years, and you don't have to repair or upgrade anything during that time, the real question I think is what my clown meme says. Is the trade off worth it? Because raising rents means much more management, more repairs, and higher vacancy. The problem is it is difficult to see if the trade off is worth it. I think some investors are anxious to earn the rents without understanding you going to market rents will result in a lot more hands on management, expenses, and vacancy. And the local managers seem to concern themselves more with high occupancy rates.

that seems higher reward for the risk.

exactly.

There is an element of uncertainty in any such decisions, but the older the buildings, the more likely a higher better use may be available. But these buildings seem to be in good condition and the only thing I think of that could afford and want the site and tear down might be a bank...and currently banks are shuttering bank branches here. I don't see any demand for the site beyond the buildings income stream.

 

[J Grant]

Well, investors should know to study their market. As for "poor" performance. If you have a renter who remains in place for years, and you don't have to repair or upgrade anything during that time, the real question I think is what my clown meme says. Is the trade off worth it? Because raising rents means much more management, more repairs, and higher vacancy. The problem is it is difficult to see if the trade off is worth it. I think some investors are anxious to earn the rents without understanding you going to market rents will result in a lot more hands on management, expenses, and vacancy. And the local managers seem to concern themselves more with high occupancy rates.

exactly.

There is an element of uncertainty in any such decisions, but the older the buildings, the more likely a higher better use may be available. But these buildings seem to be in good condition and the only thing I think of that could afford and want the site and tear down might be a bank...and currently banks are shuttering bank branches here. I don't see any demand for the site beyond the buildings income stream.

That is why your client hired you for a MV opinion. If greedy out-of-state people fail to understand the local market and the value of a tenant that pays rent vs vacant and a tenant for higher rent never materializes. then your MV might reflect a lower $ amount than the buyer or seller expects. Boo hoo.

PS- We do not tell a buyer what to pay. We tell our client the MV opinion as developed in the appraisal using a MV definition of value. The individual buyer is free to pay their purchase price by putting down more cash funds.

Sometimes I find it helpful to step away for a day or leave it overnight and come back with fresh eyes -

 

[TerryRohrer]

There are periods when "stuff" gets out of whack.

I was appraising most of the main street bars for one lender (real estate and liquor license, not going concern) in a small town (about 2,500 population) right before the last crash. Local realtors had found connections with outside money and had convinced many that this was the next Vale. One buyer, in particular, had been investing in this market for decades, but with much other people's money, and was the predominant buyer. Commercial sales reflected a very strongly inflating market that made no sense. In an effort to gauge rents, I walked both sides of Main Street and spoke with every owner/tenant that was open that day. To a person, every tenant indicated they were not making adequate profits, and were certain they would have to close if rents were increased even a little, much less by enough to justify recent sales. My highest and best use in every case was "speculative investment" and to this day I puzzle over why I never got a single question about that, though the client likely understood it all to well? Fast forward a couple of years and the big buyer was out of business and the lender owned most of the properties and had replaced most of their upper level personnel. The town just recently exceeded its 2009 population by 7 folks.

In another rural town that never recovered from the oil bust of the 1980s (so was very stable for the decades following the 1980s crash, even into the latest oil boom in the area), I was appraising a set of 6 fourplex apartment buildings. Rents were low and vacancies were low and turnover was low. The buyer was pushing for a valuation much higher than his purchase price, insisting that the rents were low and he would immediately raise rents and have instant equity. I interviewed every tenant and landlord I could find, and every owner claimed their rents were too low and could be raised, but many, after a bit of conversation and in answer why didn't they raise rents, were clearly concerned about vacancies increasing in response to rent increases.

In your case, I think the speculation from outside buyers (which you can't dismiss when they are the bulk of the market) is driving up prices faster than rents justify. While I can think of numerous avenues to adjust rents and vacancies to bring the income approach in line with the other two approaches, I would not pursue those options. I think explaining the disconnect between prices and rents is easier and cleaner (and more useful if the client is a lender) than any alternative developed that would serve to disguise that trend. There is no reliable means to reconcile the low rent/stabilized occupancy and higher rents/higher turnover unless you have perfect data somewhere within that range, in which case you would just rely on that. My preference is to leave the glaring discrepancy and reconcile that with the other approaches rather than to make it appear that all is utopian.

 

[J Grant]

Imo rents (actual, verified rents ) often give a more accurate indicator of value than sale prices and here is why-

1) Rents and income are collected and get paid with real money, not financed money. The retail or business income from a lease is what it is, and rents are paid with cash / funds and are not financed like in a one-time sale price where OPM from a mortgage is used. If wages and income top out at a certain threshold, where will the promised high $ leases com from ?

Sometimes, an area is under-rented and is poised for growth, but other times it is just people hoping to cash in or not being well informed as to the reality.
Rents are like the canary in a coal mine because when too many out-of-town speculators move in and overpay, they do not live in the area and have no qualms about walking away from the property, especially if they put little $ down. Remember the term strategic default? There is only so long an owner will be able to, or want to maintain a vacant property or one rented at a negative cash flow.

I remember all the glitzy condos that went up in Miami and some in W Palm Beach where spec buyers were promised that rich foreigners would come in and rent - they never came - local people here can not afford the rental rates that made buying one of those condos make sense.