When Market Conditions and Buyers Expectations Differ

[TerryRohrer]

Well, rents will tend to lag sales, so if prices are trending up it takes time for existing leases to expire and new owners to raise rents, experience turnover, gauge and react to changes in vacancies, etc. Also, if there is a difference between cash sales and financed sales, then the latter need to be adjusted to a cash equivalent. Lastly, the sales comparison and income approaches are necessarily related through capitalization rates (which are reliant on sales). If prices are rising, and rents are stable, buyers are realizing lower capitalization rates. Whether they are betting on increased rents and improved returns, or are satisfied with the rate of return they purchased, only time will tell if they guessed the elements correctly. The issue in Terrel's assignment is a lack of data by which to gauge vacancy rates and turnover corresponding to different rent levels. If there was sufficient data to reliably complete that task, the approaches to value would align. There is no disconnect in the usefulness of any approach to estimating market value...there is a difference in the quality and quantity of data.

 

[J Grant]

Well, rents will tend to lag sales, so if prices are trending up it takes time for existing leases to expire and new owners to raise rents, experience turnover, gauge and react to changes in vacancies, etc. Also, if there is a difference between cash sales and financed sales, then the latter need to be adjusted to a cash equivalent. Lastly, the sales comparison and income approaches are necessarily related through capitalization rates (which are reliant on sales). If prices are rising, and rents are stable, buyers are realizing lower capitalization rates. Whether they are betting on increased rents and improved returns, or are satisfied with the rate of return they purchased, only time will tell if they guessed the elements correctly. The issue in Terrel's assignment is a lack of data by which to gauge vacancy rates and turnover corresponding to different rent levels. If there was sufficient data to reliably complete that task, the approaches to value would align. There is no disconnect in the usefulness of any approach to estimating market value...there is a difference in the quality and quantity of data.

Yes,

However, a problem shows its hand when the new owners can not raise the rents ...then they have overpaid. They can not carry the property without a negative cash flow, perhaps, or it stays vacant if they let a good long-time tenant go, hoping to snare a higher-paying one.

I do not use a cap rate for small income res properties, we use a GRM, but since both are tied into sales, IMO that is a weakness of them and not a strength, especially when they are articufally spected to "line up." The gap between sale price and cost or sale price and rental income is saying something about a market imbalance-

In my opinion, the acid test of rental return vs. sale price or value amount is to use a simple income and expense statement ( which used to be required for small-income residential but recently was eliminated, probably because it revealed the truth, lol ). An income and expense statement with the value that uses actual market rents and expenses will show if the property is a negative cash flow, a positive cash flow, or break even.

Speculators are like gamblers - sometimes things work in their favor, other times not. If they use their own money they can gamble unlimited, If they use OPM - our lender client for example,, especially tax payer backed, that is where safeguards come in, one of which is supposed to be the apprasial.

 

[Gobears81]

Nothing wrong with reflecting higher rents and higher vacancy if that is the expectation. The times that I've seen non-investment grade properties with below-market leases sell, the current rents are almost disregarded by the buyers, provided that the leases are short term.

I recall appraising a property where the rents were absurdly below market, though it was - unsurprisingly - fully occupied. Every time that I drove by after that appraisal, there was a for rent sign. We subsequently appraised the property, and the rents were MUCH higher, probably too high. He went from missing the market on one side to the other, but probably would've made the most in the long run by charging what the market suggests.

 

[andrew81]

Hey, @Fernando what would fernando do?

 

[Fernando]

I was driving this morning and I saw a Walgreens that has been closed this year. Another Walgreens in the City closed across my property and has been vacant for over a year. Prior to the shoplifting spree during Covid and now, Walgreens was unheard of in closing their stores. It means commercial rents are too high in consideration of the losses endured by criminals. Unlike residential, rents for commercial can decline significantly relative to the economy.

It's always been difficult to rerent a large commercial space after a good tenant vacates.
Even in good times, I had vacancy of two years before I finally rented to a major company.
So now the good rents with cap rate of 6.75% show a $X,000,000 value.
I hope the tenant renews next year. If not, no rents thus the value of my property would be cut in half.

 

[George Hatch]

This situation is not just common with multi-tenant retail or office. It's almost more common than not with multi-family properties. An aggressive management program will usually generate higher rates of tenant turnover and higher expenses. If the occupancy rates weaken at all some property owners and managers will switch to the more conservative approach because even a little vacancy cuts significantly into their bottom line.

If you're a retailer looking to rent a storefront which would you rather rent in, a property with more vacancies or a property with fewer vacancies? What's the point of getting a low rent if the retail center has 25% vacancy and looks like a ghost town?

 

[Dublin ohio]

I was driving this morning and I saw a Walgreens that has been closed this year. Another Walgreens in the City closed across my property and has been vacant for over a year. Prior to the shoplifting spree during Covid and now, Walgreens was unheard of in closing their stores. It means commercial rents are too high in consideration of the losses endured by criminals. Unlike residential, rents for commercial can decline significantly relative to the economy.

Sounds like a chicken/egg problem

 

[Fernando]

Commercial values can be manipulated.
I can give the tenant many freebies like several months of free rent and credit in remodeling in exchange for higher future rents.
Then when tenant pays the higher rents (fooling the appraiser and investor), I can get higher valuation based on cap rates.

 

[Dublin ohio]

Commercial values can be manipulated.
I can give the tenant many freebies like several months of free rent and credit in remodeling in exchange for higher future rents.
Then when tenant pays the higher rents (fooling the appraiser and investor), I can get higher valuation based on cap rates.

That doesn't explain your illogical explanation of high rents vs theft rate

 

[Fernando]

That doesn't explain your illogical explanation of high rents vs theft rate

Walgreens were considered as good a safe tenants to appraisers back then. Walgreens was like T bonds.
When Walgreens rather close down and pay the rent (and try to sublease the premise) than stay open due to high theft, crime has affected their profits.
Walgreens usually sign a long term lease at lower rents than market. Thus Walgreens not even willing to stay paying their "low" rents.