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Valuation Issues in Today’s Market Prepared by R.K. Barnes & Associates, Inc. One of the most challenging environments ever encountered by market participants. U.S. economy has shed 5.73 million jobs since the recession began in December of 2007

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Valuation Issues in Today’s Market

Prepared by R.K. Barnes & Associates, Inc.


  • One of the most challenging environments ever encountered by market participants.

    • U.S. economy has shed 5.73 million jobs since the recession began in December of 2007

    • Job losses have extended across all job industries causing companies to downsize, consolidate, or go dark

    • The current economic climate has had a major impact on real estate

      • Most notably residential real estate

      • Although, becoming more visible in commercial real estate


As a Result of these negative influences:

  • Investors are struggling for preservation of value and maintaining ownership

    • Declining rents, declining occupancies, rising concessions, etc.

    • Foreclosure activity is rising

  • Restricted debt options

    • Many of the big banks are gone or sitting on the sidelines

    • Smaller community banks are willing but, limited in deal size

  • Declining tenant demand

  • Rising overall cap rates

  • And eroded market confidence


Valuation Issues in Today’s Market

  • Capitalization Rates

  • Tenant Risk Assessment

  • Vacancy Rates

  • Discounted Cash Flow Models/Discount Rates

    • Market Rent Changes

    • Expense Rate Changes

    • Reserves for Cap X

  • Holding Periods

  • Concessions


Overall Cap Rate Analysis-1st Qtr. 2009

Property TypeCap RateQtr. Change

Apartments6.88%+75

Warehouse7.13%+40

Regional Mall6.99%+ 3

CBD Office7.52%+38

Strip Shopping Ctr7.63%+14

Power Center7.98%+41

Suburban Office8.17%+58

Flex/R& D8.20%+44

Net Lease8.58%+73

Source: Korpacz Real Estate Investor Survey


Capitalization Rate Comments

  • One of the largest quarterly spikes was exhibited in multi-family (75 basis points). The reason is largely attributed to increasing competition via foreclosed homes and unsold condominiums which have been turned into rental units.

  • Second largest quarterly spike was net leased properties (73 basis points). Largely attributable to the large number of national retailers dismal performance over the past few months.


Capitalization Rate Comments – Local Market

  • Trends locally, generally mirror the national market as will be shown in forthcoming capitalization rates

  • Jim Dunn comments in newsletter regarding 15% cap rate….while cap rates are up, nothing we’ve seen (generally speaking) above 10%

  • Bid-ask pricing gap remains wide…many sellers have a 1-2 year ago mind set..buyers have a current mind set; although, want 1-2 year ago valuation results


Caution

  • Statistical Population is Small

  • Anomalies outside the range

    • Some can be explained

    • Some can’t be explained


Recent Retail Sales

  • Property TypeCap RateComments

  • Power Center 7.97%West End area, Mar 09

  • Strip Center8.58%Older, Nolensville Rd.

  • Strip Center7.78%Green Hills, A location

  • Strip Center7.29%Cool Springs

  • Strip Center7.27%Sumner County

  • Strip Center7.19%Rutherford County

  • Strip Center7.83%Spring Hill

  • STNL7.74%-8.41%Verizon, E. TN

  • STNL 7.9%Verizon, Rutherford Co

  • STNL 7.12%AT&T, Montgomery Co

  • STNL7.65%Rite Aid, Mont. Co. 2/09


Retail Sales – Local vs. National

  • Property TypeLocalNational

    • Power Center7.97%7.98%

    • Strip Shop Range 7.19-7.83%7.63%

    • Strip Shop Avg.7.47%7.63%

    • Net Lease Range7.12%-8.41%8.58%

    • Net Lease Avg.7.93%8.58%


Recent Office Building Sales

  • Property TypeCap RateComments

  • Med Office 8.25%Southern Hills area

  • Class A7.24%Brentwood Submarket

  • Business Ctr7.75%Cool Springs

  • Class A8.17%Brentwood

  • Property Local National

  • Suburban Range7.24%-8.25%8.17%

  • Suburban Avg.7.96%8.17%


Warehouse Sales – Local vs. National

  • Property TypeCap RateComments

  • Single Tenant8.64%Long term lease -10yrs.

  • Two Tenant7.59%Allied Drive Area, older

  • Single Tenant7.64%Interchange City 5 yr. lease

  • Flex R & D9.41%Airport Area, soft mkt.

  • Property TypeLocalNational

    • Warehouse Range7.59%-8.64%7.13%

    • Warehouse Avg.7.96%7.13%

    • Flex R & D9.41%8.20%


Recent Apartment Sales

  • Property TypeCap RateComments

  • Class B -242 Units7.62%Murfreesboro

  • Class B -113 Units6.31%Murfreesboro

  • Class B -261 Units6.26%Hermitage

  • Class A -350 Units6.02%Hermitage

  • Class A -560 Units6.13%Cool Springs Area

  • Class A -300 Units6.64%Hendersonville

  • Class B -406 Units7.28%Hickory Hollow

  • Class A -300 Units 6.93%Madison Area, Feb 09

  • Class A -216 Units7.0%West End, Mar 09

  • Class B -362 Units7.77%Antioch Area, Dec 08

  • Opportunity/Upside10.1%Foreclosure, needed work

  • Opportunity/Upside8.78%60% Occ./mismanaged


Apartment Sales – Local vs. National

  • Property TypeLocalNational

    Apartments Range6.26%-7.77%6.88%

    Apartments Avg.6.80%6.88%

    Notes: omitted the two opportunity/upside properties


Overall Capitalization Rate Forecast –Next 2 Qtrs.

  • Property TypeCurrent OARChange(bp)Average

  • Regional Mall6.99%25-10065.0 (7.64%)

  • Power Center7.98%20-12574.4 (8.72%)

  • Strip Shopping Ctr7.63%25-10045.8 (8.09%)

  • CBD Office7.52%25-10047.5 (8.00%)

  • Suburban Office8.17%0-15065.6 (8.83%)

  • Flex R & D8.20%0-10031.3 (8.51%)

  • Warehouse7.13%0-10039.6 (7.53%)

  • Apartment6.88%(50)-10046.3 (7.34%)


Tenant Risk Assessment In Valuation

  • Credit quality of the tenant has become crucial in the underwriting process

    • Ability of the tenant to pay rent today and in the future

    • Proper risk assessment

      • Understand nature of tenant’s business

      • Competitive position in the industry

      • Health of industry itself


Tenant Risk Assessment In Valuation, Contd.

  • Impact on derivation of capitalization and discount rates

  • Sources for determination of credit worthiness

    • Financial Statements

    • Analyst reports

    • Credit ratings

    • Calculate ratios or trend analysis

    • Media Articles, Publications, Etc.


Tenant Risk Assessment In Valuation, Contd.

  • How to gauge a healthy tenant?

    • Sales per square foot

    • Occupancy costs (Rent as % of Sales)

      • Dollars & Cents of Shopping Centers, International Council of Shopping Centers

    • Competition


Tenant Risk Assessment In Valuation, Contd.

  • Lenders are increasingly requesting “go dark” values requiring appraisers to consider spaces without a specific tenant in place (typically the build to suit tenant) and what impact this would have on value…


Vacancy Rates In The Valuation Process

  • Underwriting to submarkets unless there is a compelling story and/or history

  • All leases under 7 or 8 years in remaining term are subject to vacancy –including the nationals


Office Market

  • Overall vacancy at 12.8% according to CB Richard Ellis 1st Qtr. 2009 Report

  • CoStar & Excelligent both have overall vacancy at less than 10% -4th Qtr. 2008 Report

  • Markets over 10% Vacancy Include

    • Airport North19.43%

    • Airport South24.16%

    • Cool Springs/Franklin 12.26%

    • Downtown 19.80%

    • North Nashville27.21%


Office Market, Contd.

  • Sub-lease Space has almost doubled over the past three years

  • Office Condos –both sales and rents


Office Market Perspective

  • Current Overall Office Vacancy Rate 12.81% expected to peak at 15.5 to 16.0% later this year vs. National expectations to peak around 19.0% by year end

  • Late 1980’s and early 1990’s vs. 2008-09

  • 1989 Local Overall Office Vacancy Rate was 23.2% vs. today at 9.5% to 12.8%


Retail Market

  • Overall Vacancy Rate is 5.5%

  • Markets over 10%

    • E. Nashville Dickerson Pk 23.1%

    • Big Box -Rivergate 17.2%

  • Community Centers over 10%

    • Hickory Hollow11.8%

    • Donelson/Hermitage13.2%

    • E. Nashville/Dickerson73.8%

    • Hendersonville 15.9%

    • Murfreesboro10.4%


Retail Market, Contd.

  • Strip Center Markets over 10%

    • Donelson/Hermitage22.0%

    • E. Nashville/Dickerson19.5%

    • Murfreesboro24.5%

  • Neighborhood Center Markets over 10%

    • Mt. Juliet/Lebanon11.1%

  • Power Center Markets over 10%

    • Murfreesboro 10.4%


Industrial Market

  • Overall Vacancy Rate at 8.49% up 44 basis points from 4th Qtr.

  • Up 182 basis points from a year ago

  • Rates have been flat or held steady since 3rd Qtr. Of 2006


Industrial Market, Contd.

  • Concerns Submarkets over 10%

    • CBD/Polk Avenue 10.31%

    • Elm Hill Pike/I 40 East16.01%

    • Interchange City12.02%

    • Northeast/I 65 North11.24%

Source: CB Richard Ellis


Multi Family Market

  • Overall vacancy rate 9.4% (4th Qtr. 2008) – lowest rate since the late 1980’s

  • Markets above 10%

    • Briley Parkway and North Nashville at 12%

    • Nolensville Road at 14.23%

  • Shadow market of foreclosed homes, unsold condominiums and investment properties in the market. Additionally, a significant number of young people are moving back home.


DCF Vacancy Assumptions In the Valuation Model

  • Months Vacant Projections have increased across the board –simple average is up 8.61% to 7.66 months vacant

  • Tenant Retention Percentages are down 96 basis points to 68.31% vs. 69.27%

  • Underlying Vacancy & Credit Loss up 46 basis points to 5.47% from the previous 5.01%


Discounted Cash Flow Models & Discount Rates

  • Forecasting Models have been effected due to rising discount rates, more modest market rent changes, escalating expense projections, including reserves for capital expenditures.

    • Discount Rates

    • Market Rent Changes

    • Expense Changes

    • Replacement Reserves (reserves for cap x)


Discount Rates

Discount

Property TypeRateQtr. Change

Apartments9.05%+73

Warehouse8.33%+14

Regional Mall9.13%+11

CBD Office8.63%+11

Strip Shopping Ctr8.59%+10

Power Center9.52%+57

Suburban Office9.69%+57

Flex/R& D9.03%+18

Net Lease9.69% -6


Discount Rates, Contd.

  • Discount Rates for residential subdivisions have exhibited the highest spike with average up 108 basis points indicating 18.58% for the 4th Qtr. 2008 indications according to Korpacz

  • Realty Rates pegs the average rate much higher at 28.02%, representing a 500 basis point jump in the past six months.

  • The other property group that would be similarly impacted would be multi-unit sales such as residential and commercial condominiums


Market Rent Changes

  • With vacancies on the rise and prevailing market conditions initial year market rent changes have been reduced significantly.

  • Simple averages (for initial year market rent changes) are 1.29% increase which is down from 3.92% in the fourth quarter of 2008. –source Korpacz Real Estate Investor Survey –office markets only


Market Rent Changes

  • Property TypeCurrent Qtr.Average

  • Regional Mall( 3.00%)- 3.0%1.71

  • Power Center(10.00%)- 3.00%0.00%

  • Strip Shopping( 5.00%)- 3.00%1.69%

  • CBD Office( 6.00%) - 8.00%0.55%

  • Suburban Office(10.00%) - 5.00%3.23%

  • Flex R & D( 5.00%)- 3.00%1.00%

  • Warehouse( 4.00%) - 3.00%1.11%

  • Apartment ( 3.00%)- 5.00%1.74%


Expense Change Rate

  • Property TypeCurrent Qtr.Average

  • Regional Mall3.00%- 3.00%3.00%

  • Power Center1.00%- 3.00%2.75%

  • Strip Shopping3.00%- 4.00%3.13%

  • CBD Office2.00% - 3.00%2.95%

  • Suburban Office2.00% - 5.00%2.98%

  • Flex R & D2.00% - 3.00%2.94%

  • Warehouse2.00% - 5.00%3.02%

  • Apartment 2.50%- 3.00%2.93%


Replacement Reserves

  • Property TypeCurrent Qtr.AverageChange

  • Regional Mall$0.20-$0.50$0.260.00%

  • Power Center$0.10-$0.40$0.1911.76%

  • Strip Shopping Ctr$0.10-$0.60$0.2210.0%

  • CBD Office$0.10-$0.60$0.244.35%

  • Suburban Office$0.10-$1.00$0.290.00%

  • Flex R & D$0.10-$0.50$0.1820.0%

  • Warehouse$0.05-$0.35$0.147.69%

  • Apartment (unit)$100-$800$303.987.00%


Replacement Reserves

  • Replacement Reserves – are a vital component in forecasting cash flow models. This category has increased across the board with only Regional Mall and Suburban Office remaining flat.


Concessions in the Market

  • Concessions vary widely depending upon area and include excessive tenant improvement, free rent, lease buyouts, moving costs, etc.


Holding Periods in the Valuation Process

  • Some Property Types such as vacant land we are utilizing holding periods with discount rates in order to adjust for “time” or market conditions without any quantifiable adjustment data from sales


Conclusion

  • One of the most challenging times for investors

    • Job losses, companies downsizing, consolidating etc.

    • Struggle to preserve value

    • Restricted debt options

    • Diminished tenant demand


Conclusion, Contd.

  • Valuation Issues

    • Rising Capitalization Rates with forecasts for continued rise in cap rates over the next two quarters

    • Tenant Risk Assessment

    • Rising Vacancy Rates –although modest in most sectors, we have exhibited market conditions better than most national indicators

    • Expenses projected to outpace rent increase projections

    • Rising Reserves for Cap X –generally 5-10%

    • Holding Periods for some Property Types

    • Concessions are prevalent in the market


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