By Jerry Sanders, Executive Managing Director,
Landauer Valuation & Advisory
More than a simple property analysis, a good appraisal also reflects the impact of market trends on asset value. An appraiser lacking the experience or skills to correctly read the market may miscalculate the upside potential that is a critical component of real estate value.
The risk of such miscalculations has increased in 2013, due to a widely held perception that the apartment sector is overheated.
With more than $84 billion invested in multifamily transactions in 2012, the sector dominated U.S. investment sales and accounted for more than 25 percent of all commercial property transactions that year.
Many brokers and inexperienced appraisers, believing the multifamily market is universally overheated, are reluctant to conclude current values are sustainable, even when sound valuation principles support those high values.
With so much at stake, investors should take time to evaluate an appraiser’s skills and experience before ordering an appraisal.
The depth and breadth of an appraiser’s responses to the following four questions can help to determine whether a multifamily appraisal is in capable hands:
1. How do market fundamentals, or the supply and demand factors that drive long-term property value, relate to the property?
2. Who are the potential buyers for this property?
3. How do those buyers typically add value to acquired properties?
4. How will the appraiser factor answers to the previous three questions into his or her assumptions and into the property’s risk-adjusted return for valuation purposes?
A skilled appraiser with a thorough understanding of the market fundamentals relating to a particular property will properly “reflect the market” and project sound stabilized net operating incomes, appropriate overall capitalization rates and sound value conclusions.
Just because a market isn’t one of the so called “Sexy Six” gateway cities (Washington D.C,. Los Angeles, San Francisco, New York City, Boston and Seattle) with high barriers to entry does not mean that it lacks sound long-term fundamentals, or that investors will not compete enthusiastically for the acquisition of its properties.
In fact, a look at the NCREIF Property Index published March 15, 2013 shows that some secondary markets produce the highest risk-adjusted returns. According to NCREIF, Texas posts three of the top seven risk-adjusted market returns. These markets may have the greatest upside and sustainability of reported values.
In addition, Urban Land Institute has included Austin, Texas, to the hot market list because of the demand created by growth in the energy and technology industries.
A look at the fundamentals within these markets could demonstrate why. Supply factors include total inventory, total inventory lost to obsolescence, and new construction. Nationally, new construction added 167,000 multifamily units in 2011 and a little more than 200,000 units in 2012. Freddie Mac projects completion of another 800,000 units by 2015.
Counterbalancing that supply growth is a significant increase in demand. Freddie Mac projects the number of renter households to grow by 1.7 million between 2012 and 2015. That portends strong demand for U.S. multifamily housing for years to come.
Freddie Mac based its projections in part on several trends. Those included decreasing discretionary income in households with modest income growth and high consumer and student loan debt; tougher home-loan qualifications; ongoing residential foreclosures; increasing immigration and population growth in age groups where loan qualifications are the lowest; delayed Baby Boomer retirement; a cultural shift toward renting; migration to urban areas; rising interest rates; and declining availability of single-family bargains as institutional buyers move into the sector.
In determining demand for a multifamily property, appraisers consider population growth, demographics job growth, education levels, household income growth, and the property’s relative desirability with respect to competing properties. The latter would reflect amenities, schools, retail support and crime rates.
The appraiser must analyze and relate demand factors directly to the submarket and the subject property. For instance, the appraiser must determine whether population growth is attributed to people relocating to the market and in what age category. Younger residents tend to be renters rather than homebuyers since they want to maintain mobility for employment and choose not to be weighed down by a mortgage.
With regard to job growth, the appraiser must ask whether there is industry diversification, and is it primarily blue or white collar growth?
If the property being analyzed is a Class B asset with steady projected job growth in primarily the blue collar sector, it could be a positive indicator for the property’s long-term performance. In addition, an area’s educated and skilled labor force will attract employers, which will also strengthen the market.
Once an appraiser understands how the fundamentals within the national market and submarket relate directly to the property, an appraiser with sound judgment will have much less reason to question whether a market is overheated or whether values are sustainable.
In addition, armed with first-hand knowledge of who the current buyers are and how they behave, the appraiser will be able to prudently mirror the market and can avoid errors in judging upside potential and, in-turn, undervaluing a multifamily asset.
Investor interest in the multifamily market is intense. With Landauer Valuation & Advisory, your multifamily asset valuation is always in capable hands.