Revisiting Your Investment Property Goals 

As an owner of investment commercial real estate today, you may be wondering about the question above. We are constantly bombarded with economic stories on REO properties, quantitative easing, fed funds rates, debt ceilings, cap rate directions, Affordable Care Act, interest rate trends, etc.

While each of these topics do impact our economy, they can also impact the valuation and most ideal time to sell an income property investment. However, by focusing on the fundamentals, we can greatly simplify the decision-making process. For our discussion, let’s define fundamentals as physical condition, financial state and economic realities.

Physical state refers to the condition of a property in general. Does deferred maintenance exist? Are the roof and mechanical systems in need of repair? In other words, are there issues that would necessitate capital outlay by a new owner to bring the property into good working order, thus impacting the property’s value?

Financial state refers to the issues impacting cash flow generated from existing or new leases at the property. From an investor’s perspective, major value enhancers are long-term leases, tenant credit and operating history, lease structure and annual rental escalations. Lease provisions having an adverse impact on the value of the property would be things such as encumbrances, termination options or non-pass through expenses resulting in potential cash flow erosion.

Economic realities refer to the state of the real estate investment market and associated issues that have direct impact on property value and investor sentiment. Those items include such things as interest rate levels and trends, investor demand, current market vacancies, financial underwriting and amount of debt and equity in the market.

So let’s say an owner of a property believes the property is a candidate for sale. How then does the owner confirm their opinion of fundamental soundness and, more importantly, the property’s value?

An independent investment analysis for your property prepared by a local expert will aid greatly in the process. The analysis should be sufficient in detail to make a convincing argument for the property’s value in light of its fundamental characteristics and provide insight not only into the subject property, but comparable properties as to current lease rates and recent sales. Doing so will provide direct insight as to investor appetite and yield expectations for your particular property type. Applying these yields to the property’s financial characteristics will allow for a good estimation of value, taking into account current lender underwriting terms. This service should be provided for free to the owner. If not, find another source.

Armed with a realistic estimation of subject property value, the owner is perhaps now ready to take the property to market. But should they sell at this point in time? Is there sufficient owner motivation to suggest such? The answer to this question can be as simple as the need to dissolve an untenable partnership or to free up frozen equity to be redeployed in a more productive manner. Motive, combined with strong property fundamentals, suggest the subject may be a prime sales candidate (provided current market conditions are favorable).

Here are a few points to consider if you are an investment property owner considering this last piece of the puzzle:

  • Quantitative easing is in its third phase. The effect, as intended, has been to hold treasury and mortgage rates at artificially low levels. The Fed’s purchasing of notes and securities is expected to taper off going into 2014, with the potential and likelihood to see higher interest rates. And remember, interest/capitalization rates have an inverse relationship to property pricing – the higher the interest/capitalization rate, the lower the valuation of the property.
  • Excessive investor appetite exists in the market from REITs (Real Estate Investment Trust), institutions and private sector investors, resulting in strong investor demand which results in Cap Rate Compression and increased asset value.
  • Abundant equity in the market, coupled with the low cost of debt, has contributed to Cap Rate Compression and high property values not unlike those last seen in the peak market of 2007.
  • As with the last significant cycle, we witnessed a flight to quality with investors focusing on core assets located in primary markets. The result has been downward pressure on yields and an increase in property values. As this has taken place, many investors are turning to secondary and tertiary markets such as the Space Coast to rectify the issue.

From a real estate valuation perspective, these points may not add up to a “perfect storm,” but most arguably should warrant an investment property owner taking the time to revisit his or her goals and plans for the assets owned.

 

Phillip Faircloth is senior vice president of investment properties at Lightle Beckner Robison, Inc. Commercial Real Estate Services.