When Market Conditions and Buyers Expectations Differ

[J Grant]

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.

? If actual market rents are lower than the "expectation"<, then where do those higher rents come from...what are they based on?

 

[Gobears81]

? If actual market rents are lower than the "expectation"<, then where do those higher rents come from...what are they based on?

The analysis assumes knowledgeable buyers - so if the rents are below market, they should, in theory, be aware of this. Different concept, but many of the same forces impacting market value (economic, governmental, etc) impact market rent, plus the ongoing rent vs buy conundrum. I think pretty much all of us have been in a market where rents have increased quite a bit over the past few years vs so there is often a high likelihood that current rents are less than if leased to a new tenant.

 

[J Grant]

The analysis assumes knowledgeable buyers - so if the rents are below market, they should, in theory, be aware of this. Different concept, but many of the same forces impacting market value (economic, governmental, etc) impact market rent, plus the ongoing rent vs buy conundrum. I think pretty much all of us have been in a market where rents have increased quite a bit over the past few years vs so there is often a high likelihood that current rents are less than if leased to a new tenant.

what aobut all those markets where commercial buildings and stores are abandoned because they can;t get any rent, or any tenant even at a lower rent? Isee that all over here. Others report it seein ihteir areas. Idk, is your area immunte to it ?.


It is misleading to present market rents as something other than what they are.
That seemed to be what the OP was struggling with - unrealistic investor projections in prices not supported by what properties are actually renting for,

Sometimes, an area with lower rents is poised for growth,

If that does not happen, and buyers overpay for properties, that is when we see either rents reduced or units sit vacant and then entire buildings abandoned or sold at fire sale prices. How long can an owner sustain a negative cash flow or carrying vacant units?

 

[J Grant]

I see some failed or failing commercial buildings and shopping strips or alls here being bought to be razed and then redeveloped for mixed-use res or entirely transformed to residential - but that is very expensive and ot the project of a typical indibual commerical investor looking to buy a property for income.

Other commercial buildings are thriving, typical medical or high-demand spaces....but to pretend all is well on the commercial front, how is that possible- just walk around and see all the vacant storefronts and parking lots with nobody in them. And this is a populated, fairly affluent area. Online shopping and remote business, for better or worse, have changed things.

 

[Gobears81]

what aobut all those markets where commercial buildings and stores are abandoned because they can;t get any rent, or any tenant even at a lower rent? Isee that all over here. Others report it seein ihteir areas. Idk, is your area immunte to it ?.


It is misleading to present market rents as something other than what they are.
That seemed to be what the OP was struggling with - unrealistic investor projections in prices not supported by what properties are actually renting for,

Sometimes, an area with lower rents is poised for growth,

If that does not happen, and buyers overpay for properties, that is when we see either rents reduced or units sit vacant and then entire buildings abandoned or sold at fire sale prices. How long can an owner sustain a negative cash flow or carrying vacant units?

I can assure you that my area is not immune to abandoned buildings

Not sure what you mean about the market rents being misleading. I agree that investors can often have unrealistic expectations, which has been more of an issue in strong markets. But, in increasing markets, using comparable rentals that were recently signed is of greater importance. I still get surprised when hearing of investor's expectations for rents - yet they are often getting those rents in this market! But that is still where our job as appraisers comes in - we assume competent management, and if they are trying to get $20/ SF rents when market rent is $15, that could (eventually) qualify as mismanagement if they are unwilling to reset their expectations. Tenant rollover is a necessary part of managing commercial properties. Would a LL be better off charging 5% below market to ensure long-term occupancy by a strong tenant? I think most would be willing to do so, but the challenge is determining whether that lower rent would actually ensure longer-term occupancy - otherwise, they are leaving money on the table.

 

[J Grant]

Not every residential purchase or investment property turns out to be a winner. That is why RE is considered a risky investment, but of course, with risk comes rewards.
We are supposed to lay out the good, bad, and ugly about a property and its market, what is changing, and what the current state of rents and demand is, etc.

Lay out the real facts as well as the trends and let teh client decide. If they do not have realistic information, they can not make a well-informed decision. a

Our role

I can assure you that my area is not immune to abandoned buildings

Not sure what you mean about the market rents being misleading. I agree that investors can often have unrealistic expectations, which has been more of an issue in strong markets. But, in increasing markets, using comparable rentals that were recently signed is of greater importance. I still get surprised when hearing of investor's expectations for rents - yet they are often getting those rents in this market! But that is still where our job as appraisers comes in - we assume competent management, and if they are trying to get $20/ SF rents when market rent is $15, that could (eventually) qualify as mismanagement if they are unwilling to reset their expectations. Tenant rollover is a necessary part of managing commercial properties. Would a LL be better off charging 5% below market to ensure long-term occupancy by a strong tenant? I think most would be willing to do so, but the challenge is determining whether that lower rent would actually ensure longer-term occupancy - otherwise, they are leaving money on the table.

Well, if the market rents are actual rents and they are higher than old leases, there is no problem and nothing to discuss ! just explain why more recent leases are used and why older leases may be lower.

But that was not the Op's situation....and with so many commercial markets in decline, I doubt it is a problem of leaving money on the table.

Buyers never suffer if they underpay, and that is what most smart investors do because they come in early on a trend- or with enough deep pockets, they can transform an area. But those who come in later in a trend might seem to enjoy the higher leases, but if they pay very high prices for the property, their cash flow can be anemic - and if there is ever a downturn, they are vulnerable, stuck with this big fat mortgage and vacant units. Just saying,

 

[Gobears81]

I agree with you, but the media seems to have extrapolated "office" to all commercial properties, and not every commercial market is nearly as bad as we keep hearing. Some are still quite strong and dealing with increasing rents.

 

[Terrel L. Shields]

Some are still quite strong and dealing with increasing rents.

What I am seeing is increasing rents and property prices but more businesses having issues with paying for it all out of proceeds. Although gross tax receipts are increasing, it's clear cost is leaving a narrower margin to the businesses.

 

[Joe Flacco]

I was at American Dream over the weekend and it seems like half of the retail spaces are still vacant. Seems like more food vendors than stores.

 

[Joe Flacco]

Locally, it seems like a lot of restaurants are closing. Both small and big.