financially distressed asset valuation and pricing

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Concepts. Market valueThe most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently, knowledgably, and assuming the price is not affected by undue stimulus.Source: Office of the Comptroller of the Currency.

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1. Financially Distressed Asset Valuation and Pricing Thomas O. Jackson, Ph.D., AICP, MAI, CRE, FRICS Texas A&M University and Real Property Analytics, Inc. 979-690-1755 [email protected] [email protected]

3. Concepts “As is” market value The price at which a third-party purchaser could acquire the property in its “as is” condition and then cover all the remaining costs associated with completing construction, sellout, or lease up and earn a market-based level of profit for doing so. Acknowledges that entrepreneurs demand compensation for purchasing distressed real estate. Source: Appraisal Institute, Appraising Distressed Commercial Real Estate

4. Concepts Liquidation value The most probable price which a specified interest in real property is likely to bring under all of the following conditions: Consummation of a sale will occur within a severely limited future marketing time specified by the client. Actual market conditions are those currently obtained for the property interest appraised. Source: Dictionary of Real Estate Appraisal, 4th Edition

5. Concepts Liquidation value (continued) The buyer is acting prudently, knowledgably, and is typically motivated The seller is under extreme compulsion to sell The buyer is acting in what he or she considers his or her best interests A limited marketing effort and time will be allowed for the completion of the sale Payment will be made in cash in U.S. Dollars or in terms of financial arrangements comparable thereto

6. Concepts Disposition value The most probable price that a specified interest in real property is likely to bring under all of the following conditions: Consummation of a sale will occur within a limited future marketing period specified by the client The actual market conditions currently prevailing are those to which the appraised property is subject The buyer and seller are each acting prudently and knowledgably The seller is under compulsion to sell. The buyer is typically motivated

7. Concepts Disposition value (continued) Both parties are acting in what they consider their best interests. An adequate marketing effort will be made in the limited time allowed for the completion of the sale. Payment will be made in U.S. dollars or in terms or financial arrangements comparable thereto. The price represents the normal consideration for the property sold, unaffected by special or creative financing or sales concessions granted by anyone associated with the sale. Source: Dictionary of Real Estate Appraisal, 4th Edition

8. Concepts Distressed real estate In general, distressed real estate represents those properties suffering from higher than typical vacancies Properties where effective rents of prices have declined significantly in order to attain lease up or sale Source: Appraisal Institute, Appraising Distressed Commercial Real Estate

9. Concepts Net realizable value SP = Pr (X<=1) x MV NRV = SP – (C – R) / (1+ r)n SP = selling price MV = market value Pr (X>=1) = probability of one or more offers in holding period C = carrying costs R = effective gross income r = market discount rate

10. Valuation Issues As is market value High vacancies Lower net income Below market rents As though stable Assumes stabilized occupancy Assumes market rents Current date of value (hypothetical condition) When stabilized Market analysis to determine future date when stabilization may occur (extraordinary assumption) Future date of value

11. Valuation Issues Lease up adjustment Difference between current (as is) occupancy and rents and stabilized occupancy Projection of rent loss until stabilization Difference between hypothetical as if stable and as is scenarios until stabilization is reached Present value of rent loss Adjustment to current as if stable value Adjustment to sale and cost approach estimates

12. Valuation Issues Income capitalization approach Yield capitalization (DCF analysis) Estimating buyer’s or market segment’s yield can be complex Few or no transactions Little market activity Constrained capital markets

13. Valuation Issues Market simulation Simulated transactions More emphasis is placed on how people make decisions rather than what they decided because no transactions have transpired in the current market DCF analysis given its explicit input format might be most appropriate model to simulate buyer behavior Source: T. Grissom, Appraising without Comparables, 1988, Texas A&M Real Estate Center)

14. Valuation Issues Yield and income capitalization rates Income capitalization rates composed of the yield rate yield rate and expectations of property value and income growth Property models RO = YO - A RO = YO - ?O a RO = YO - ?OSFF RO = YO - ?O1/n RO = YO - CR

15. Valuation Issues Built up or blended rates RO = ( E x RE ) + (M x RM) RE = (RO - (M x RM)) / E Ellwood RO = (YE – M(YE + P 1/SFF – RM) ?o 1/SFF) / (1 + ?i J or K) Ellwood in Akerson Format Weighted average of mortgage and equity requirements adjusted for equity buildup due to loan paydown and appreciation

16. Valuation Issues Final thoughts Is this a dilemma in which the value cannot be estimated without knowing the capital structure and the capital structure cannot be known without knowing the value?

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