When Market Conditions and Buyers Expectations Differ

[George Hatch]

Ask away. The forum is supposed to be about such exchanges of info.

Believe it or not the changes in cap rates tend to lag the changes in mortgage interest rates. Aside from that the overall rate is only partly comprised of the mortgage end; the equity end of the investment has it's own rate which will reflect the investor expectations for changes to both income and resale value going forward. If the mortgage rate is 8% and the financing terms are for a 70% LTV then .08 x .7 = .0560. Anything above that goes to offset the investor's end and anything under that isn't debt servicing without the investor coming out of pocket.

If the investors think a market segment is going to increase in value over the next couple years or if they think the rents will increase then that will explain why they might run with negative cash flow. For a while. The flip side of that is that comm loans commonly get rewritten every 5 years or 10 yr intervals. So interest rates from 2019 might not be available anymore, which when combined with any weakness in the occupancy or rents is enough to push some of these properties into a forced transaction. And/or foreclosure or short sale.

Experienced investors are all about the dollars and cents with not a whole lot of sentimentality involved. But they don't always do what we expect them to do. The recent changes to office and retail occupancy has been taking it's toll on the pricing for such property types. Regardless of the occupancy, the fixed overhead continues. If a building is maxed on financing and might needs 75% or 80% occupancy to cover the expenses and mortgage. If the occupancy drops below that or the rents drop then it doesn't take very long before the loan fails.

 

[Joe Flacco]

Is it the actual cap rates that lag the market or is it the appraisals and the appraisal methodology developing cap rates that lag the market?

Obviously, there are a lot of moving parts with mortgage rates being one of many.

What are the other methods of developing cap rates you mentioned?

 

[George Hatch]

Depending on the property type an appraiser might approach from a mortgage/equity buildup or they might survey brokers or they might use published studies. Some of that depends on what the property type is and the level of sophistication being used by the buyers and sellers.

I only favor using the published studies and surveys if they directly address the market segment I'm working with.

If an appraiser is watching the actives and recently withdrawn listings to see what those sellers think then the lag in the timing isn't as big a problem as it might seem. I can know what they want and I can know what they have been getting in comparison to what they tried to get. Not to mention the point that most comm appraisals work from the macro to the micro to begin with. So the market analysis isn't supposed to resemble running a single query in a single database and then picking the 3 highest prices on the list.

Most of these non-res property types are nowhere near as volatile as the SFR market. I just appraised a vacant lot that increased in value by 30% during the same time frame in which the SFR medians doubled. "some" doesn't mean "all", though. Like when a few of these office properties have declined in value even while the SFRs were increasing. Different types of buyers are doing different things.

 

[Tom D]

Basically, Red Lobster can only raise prices so much based on the type of restaurant it is. It can't pay high-end rents in markets where demand for space has pushed costs up.
The chain does not have national pricing, but its business model is essentially being a value provider of sit-down seafood meals.

As part of its bankruptcy process, Red Lobster also had over 100 locations it wanted to keep open but only with concessions from its landlords. In most cases, this was more than just rent forgiveness. The company also wanted its landlords to forgive bank rent.

Now, after it shared that its new owner will be RL Purchaser LLC, a stalking horse bidder made up of Red Lobster’s lenders, the company continues to shut down locations.
A bankruptcy court still has to approve that deal. The company also filed a number of court documents designed to help it get out of its leases in 23 more locations before the end of August.
It's not, of course, open in the over 100 locations that have already closed and soon that fate will likely be met by 23 other Red Lobsters, assuming the bankruptcy court approves the closures.