Putting a value on investment real

Several qualitative factors have a great deal of impact on value

One of the first columns I wrote for the New Hampshire Business Review was back in December 2006. It dealt with how to determine what a piece of property is worth.

I’ve handled many transactions since then and have found that valuation is one of the most difficult parts of my practice. I have really developed an appreciation for the work that appraisers do.

I have also found that several qualitative factors, like location, property quality, physical characteristics and tenant quality have a great deal of impact on value.

Let’s look at some standard valuation techniques and see how these factors come into play.

One of the most frequently used valuation tools is comparable sales, or “comps.” The idea is that you can determine the value of a property by looking at recent sales of comparable properties, making adjustments for some of the qualitative factors noted above.

The biggest challenge over the past few years has been finding recent sales of comparable properties, especially when dealing with unusual or one-of-a-kind properties. I frequently get calls from appraisers asking me about deals that took place many years ago, because they’re trying to find anything that remotely resembles the assignment they are currently working on.

Appraisers have not only had trouble finding comps, but when they do, they need to make financial adjustments based on where we are in the market. When the market was going down, they had to adjust their value opinions to reflect that. My appraiser friends have been telling me lately that they have not been making adjustments the last year or so, feeling that the market had bottomed, but they are now thinking that they need to make upward adjustments, since the market appears to be improving.

Even when you find what looks to be a perfect comp, the reality is that every property is unique. I have been marketing a 60,000-square-foot industrial property in the Manchester airport area, and know that a few similar buildings have sold recently. It has been fairly easy to determine how much buyers paid on a per-square-foot basis for those properties.

But how comparable are they? Mine is on a ground lease, has fairly standard ceiling height, is fully air-conditioned, has numerous loading docks and more-than-average power capacity.

Both of the other buildings are on owned land. One of them has a tenant for whom the building was specifically constructed, so it may not be a fit for every user. Another is not so well-located, but it has higher-than-usual ceilings, which have become important to many users.

You can see that there is as much art as there is science in looking at these various buildings and trying to make adjustments based on their specific characteristics.

Market knowledge

Many investment properties are valued on the income capitalization approach, or CAP rate. I used to think this was a fairly direct valuation method. You gather the income and expenses related to the property, determine the net operating income (NOI) and then apply an appropriate CAP rate in order to determine value.

What I have found is that there is less than universal agreement on the types of income and expenses that go into determining NOI, or that there can be variations on how to determine some of the expenses. For example, vacancy and management expenses are typically included on the expense side. But how much vacancy do you use? How do you apply an appropriate management fee? Some people require that you assign an amount for reserves before calculating NOI.

So I have really scaled back on quoting NOI to prospective purchasers. I generally provide the best income and expense information I can get from the owner, and then suggest to buyers that they run their own calculations to determine NOI.

CAP rates are even more problematic, especially in a smaller market like New Hampshire, where privately held investment properties far exceed institutional types. The published CAP rates that you might see in the trade journals often come from larger deals in larger trading areas than ours, and are probably not appropriate numbers for us.

If I’m not sure about NOI, I’m certainly not sure about the CAP rate, or what the expectations are on the part of the investor, so I generally don’t quote either one.

Local market knowledge is always important when dealing with values. I was marketing a local strip center recently, and we reached an agreement on price with a buyer. A few weeks into the deal, the seller called me and wanted to know why a similar-size retail strip sold for a much higher price.

I was able to get enough information to inform my client that the cash flow from the tenants in the property that had sold was much higher than theirs, and the tenants were “national” rather than local or regional. However, the CAP rate my clients were getting was stronger than the rate for the one they were calling about, and they felt better after getting all of the information.

I’ve been involved with a couple of other deals that have brought in even more measurements of value. Did you know that car washes trade on multiples of gross sales? NOI and CAP rates are of some interest, but it appears that appraisers are more focused on car counts and gross sales than the more typical valuation factors.

Multifamily properties often trade on unit values. Prospective buyers are always asking what the price is per unit. I was able to use this on a 12-unit building I sold, since we knew the per-unit price for a similar building that sold recently. This is not always an appropriate tool, but seems to be used heavily in that asset category.

The longer I practice commercial real estate brokerage, the more the old adage comes into play; the more you know, the more you don’t know. But I do enjoy what I do and the challenges that come with it.

Dan Scanlon, an adviser with Grubb & Ellis|Northern New England, Manchester, focuses on business tenant representation and investment sales. He can be reached at 603-206-9605 or djs@grubbellisnne.com.