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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.


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  • 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


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As a Result of these negative influences: market participants.

  • 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


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Valuation Issues in Today’s Market market participants.

  • 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


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Overall Cap Rate Analysis-1 market participants.st Qtr. 2009

Property Type Cap Rate Qtr. Change

Apartments 6.88% +75

Warehouse 7.13% +40

Regional Mall 6.99% + 3

CBD Office 7.52% +38

Strip Shopping Ctr 7.63% +14

Power Center 7.98% +41

Suburban Office 8.17% +58

Flex/ R& D 8.20% +44

Net Lease 8.58% +73

Source: Korpacz Real Estate Investor Survey


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Capitalization Rate Comments market participants.

  • 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.


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Capitalization Rate Comments – Local Market market participants.

  • 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


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Caution market participants.

  • Statistical Population is Small

  • Anomalies outside the range

    • Some can be explained

    • Some can’t be explained


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Recent Retail Sales market participants.

  • Property Type Cap Rate Comments

  • Power Center 7.97% West End area, Mar 09

  • Strip Center 8.58% Older, Nolensville Rd.

  • Strip Center 7.78% Green Hills, A location

  • Strip Center 7.29% Cool Springs

  • Strip Center 7.27% Sumner County

  • Strip Center 7.19% Rutherford County

  • Strip Center 7.83% Spring Hill

  • STNL 7.74%-8.41%Verizon, E. TN

  • STNL 7.9% Verizon, Rutherford Co

  • STNL 7.12% AT&T, Montgomery Co

  • STNL 7.65% Rite Aid, Mont. Co. 2/09


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Retail Sales – Local vs. National market participants.

  • Property Type Local National

    • Power Center 7.97% 7.98%

    • Strip Shop Range 7.19-7.83% 7.63%

    • Strip Shop Avg. 7.47% 7.63%

    • Net Lease Range 7.12%-8.41% 8.58%

    • Net Lease Avg. 7.93% 8.58%


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Recent Office Building Sales market participants.

  • Property Type Cap Rate Comments

  • Med Office 8.25% Southern Hills area

  • Class A 7.24% Brentwood Submarket

  • Business Ctr 7.75% Cool Springs

  • Class A 8.17% Brentwood

  • Property Local National

  • Suburban Range 7.24%-8.25% 8.17%

  • Suburban Avg. 7.96% 8.17%


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Warehouse Sales – Local vs. National market participants.

  • Property Type Cap Rate Comments

  • Single Tenant 8.64% Long term lease -10yrs.

  • Two Tenant 7.59% Allied Drive Area, older

  • Single Tenant 7.64% Interchange City 5 yr. lease

  • Flex R & D 9.41% Airport Area, soft mkt.

  • Property Type Local National

    • Warehouse Range 7.59%-8.64% 7.13%

    • Warehouse Avg. 7.96% 7.13%

    • Flex R & D 9.41% 8.20%


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Recent Apartment Sales market participants.

  • Property Type Cap Rate Comments

  • Class B -242 Units 7.62% Murfreesboro

  • Class B -113 Units 6.31% Murfreesboro

  • Class B -261 Units 6.26% Hermitage

  • Class A -350 Units 6.02% Hermitage

  • Class A -560 Units 6.13% Cool Springs Area

  • Class A -300 Units 6.64% Hendersonville

  • Class B -406 Units 7.28% Hickory Hollow

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

  • Class A -216 Units 7.0% West End, Mar 09

  • Class B -362 Units 7.77% Antioch Area, Dec 08

  • Opportunity/Upside 10.1% Foreclosure, needed work

  • Opportunity/Upside 8.78% 60% Occ./mismanaged


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Apartment Sales – Local vs. National market participants.

  • Property Type Local National

    Apartments Range 6.26%-7.77% 6.88%

    Apartments Avg. 6.80% 6.88%

    Notes: omitted the two opportunity/upside properties


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Overall Capitalization Rate Forecast –Next 2 Qtrs. market participants.

  • Property Type Current OAR Change(bp)Average

  • Regional Mall 6.99% 25-100 65.0 (7.64%)

  • Power Center 7.98% 20-125 74.4 (8.72%)

  • Strip Shopping Ctr 7.63% 25-100 45.8 (8.09%)

  • CBD Office 7.52% 25-100 47.5 (8.00%)

  • Suburban Office 8.17% 0-150 65.6 (8.83%)

  • Flex R & D 8.20% 0-100 31.3 (8.51%)

  • Warehouse 7.13% 0-100 39.6 (7.53%)

  • Apartment 6.88% (50)-100 46.3 (7.34%)


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Tenant Risk Assessment In Valuation market participants.

  • 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


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Tenant Risk Assessment In Valuation, Contd. market participants.

  • 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.


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Tenant Risk Assessment In Valuation, Contd. market participants.

  • 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


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Tenant Risk Assessment In Valuation, Contd. market participants.

  • 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…


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Vacancy Rates In The Valuation Process market participants.

  • 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


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Office Market market participants.

  • 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 North 19.43%

    • Airport South 24.16%

    • Cool Springs/Franklin 12.26%

    • Downtown 19.80%

    • North Nashville 27.21%


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Office Market, Contd. market participants.

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

  • Office Condos –both sales and rents


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Office Market Perspective market participants.

  • 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%


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Retail Market market participants.

  • 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 Hollow 11.8%

    • Donelson/Hermitage 13.2%

    • E. Nashville/Dickerson 73.8%

    • Hendersonville 15.9%

    • Murfreesboro 10.4%


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Retail Market, Contd. market participants.

  • Strip Center Markets over 10%

    • Donelson/Hermitage 22.0%

    • E. Nashville/Dickerson 19.5%

    • Murfreesboro 24.5%

  • Neighborhood Center Markets over 10%

    • Mt. Juliet/Lebanon 11.1%

  • Power Center Markets over 10%

    • Murfreesboro 10.4%


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Industrial Market market participants.

  • 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


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Industrial Market, Contd. market participants.

  • Concerns Submarkets over 10%

    • CBD/Polk Avenue 10.31%

    • Elm Hill Pike/I 40 East 16.01%

    • Interchange City 12.02%

    • Northeast/I 65 North 11.24%

Source: CB Richard Ellis


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Multi Family Market market participants.

  • 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.


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DCF Vacancy Assumptions In the Valuation Model market participants.

  • 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%


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Discounted Cash Flow Models & Discount Rates market participants.

  • 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)


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Discount Rates market participants.

Discount

Property Type Rate Qtr. Change

Apartments 9.05% +73

Warehouse 8.33% +14

Regional Mall 9.13% +11

CBD Office 8.63% +11

Strip Shopping Ctr 8.59% +10

Power Center 9.52% +57

Suburban Office 9.69% +57

Flex/ R& D 9.03% +18

Net Lease 9.69% -6


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Discount Rates, Contd. market participants.

  • 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


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Market Rent Changes market participants.

  • 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


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Market Rent Changes market participants.

  • Property Type Current 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%


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Expense Change Rate market participants.

  • Property Type Current Qtr. Average

  • Regional Mall 3.00%- 3.00% 3.00%

  • Power Center 1.00%- 3.00% 2.75%

  • Strip Shopping 3.00%- 4.00% 3.13%

  • CBD Office 2.00% - 3.00% 2.95%

  • Suburban Office 2.00% - 5.00% 2.98%

  • Flex R & D 2.00% - 3.00% 2.94%

  • Warehouse 2.00% - 5.00% 3.02%

  • Apartment 2.50%- 3.00% 2.93%


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Replacement Reserves market participants.

  • Property Type Current Qtr. AverageChange

  • Regional Mall $0.20-$0.50 $0.26 0.00%

  • Power Center $0.10-$0.40 $0.19 11.76%

  • Strip Shopping Ctr $0.10-$0.60 $0.22 10.0%

  • CBD Office $0.10-$0.60 $0.24 4.35%

  • Suburban Office $0.10-$1.00 $0.29 0.00%

  • Flex R & D $0.10-$0.50 $0.18 20.0%

  • Warehouse $0.05-$0.35 $0.14 7.69%

  • Apartment (unit) $100-$800 $303.98 7.00%


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Replacement Reserves market participants.

  • 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.


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Concessions in the Market market participants.

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


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Holding Periods in the Valuation Process market participants.

  • 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


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Conclusion market participants.

  • One of the most challenging times for investors

    • Job losses, companies downsizing, consolidating etc.

    • Struggle to preserve value

    • Restricted debt options

    • Diminished tenant demand


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Conclusion, Contd. market participants.

  • 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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