COVER STORY, MAY 2010

EVALUATING PROPERTY VALUES
Today’s commercial property valuations are all about cash flow. Rethink everything: tenants, rents, operations expenses, financing and planned improvements.
By Jaime Lackey

Property values are down across the board and across the nation. What are the most important considerations for property owners who want to maintain values? To find out, we talked with Jeffrey Rogers, president and COO of New York-based Integra Realty Resources, the largest commercial real estate valuation and counseling firm in United States.

We asked Rogers to comment on strategies for maintaining or improving property values in general. However, please remember that each commercial property is different and property owners should consult professionals for recommendations specific to a certain property and economic situation.

NREB: What are the biggest mistakes property owners make when trying to maintain or improve the value of a commercial property in a down economy?

Rogers: One of the biggest missteps we see from owners is the failure to reevaluate plans that were developed during a different market cycle. When market cycles change, any additional investments or improvements planned for the property, but not yet completed, need to be reevaluated to determine if the proposed improvements still provide a return on investment.

Another problem we see from owners is the failure to take advantage of the current market conditions. In a down market, every agreement for service and every level of financing should be reevaluated and, if possible, renegotiated to reflect the realities of the current market. Vendors and capital providers expect fall-out in a down economy so these types of discussions are common.

NREB: What are the most important considerations for cash-strapped property owners that are dealing with distressed properties?

Rogers: Every area of the property and its financing need to be evaluated. First, determine the stabilization factor of the property. For example, when are the leases rolling over? Are the current leases at market or near market? How strong are the tenants? How strong is the property? To put it another way, “What is my worst case stabilization rate?” On the expense side, the owner needs to look for ways to significantly decrease operating expenses.

Once this analysis is done, the owner needs to evaluate the capital structure. Does the debt level reflect the new value of the property and, more importantly, can the property service the debt and operating expenses under a number of downside scenarios? The owner needs to start exploring options with the current debt holders. These are the times when relationships matter.

To complete the analysis, the owner must evaluate the property relative to his portfolio and current liquidity. For example, how does this property support the portfolio? What will a loss do to the property owner financially? Is the property personally guaranteed or collateralized beyond the underlying property?

Once all of this analysis is completed, property owners can then develop a reasonable action plan with a turnaround strategy.

NREB: Say I own an office building that I need to sell. This property has considerable vacancy. Should I try to lease it up, even at lower rates, or sell it with high vacancy?

Rogers: In general, a stabilized property (even leased with lower market rental rates) will sell better than a vacant property. Of course, tenant quality receives a great deal of scrutiny in a down market. Thus, leasing with a quality tenant is crucial for receiving the full benefit of the lease. Today’s valuations are all about cash flow.

With a vacant property, there is more risk involved in getting it leased. Moreover, the timing of when the property is leased is a big question. In situations of increasing vacancies in a worsening market, cash flow projections from vacant space may not be taken into consideration until it is reasonable to expect that the space will be leased. If you have vacant space leased with a strong tenant, even at lower rates reflecting the current market, the property will have more value absent other factors.

NREB: How does this logic apply to other property types, like retail and multifamily? Should an owner make every effort to increase occupancy before listing a property for sale?

Rogers: It is the same as with office space. Of course, there are some special situations where a potential buyer wants to repurpose the property and there is a value of having the property vacant so that construction can be started sooner. However, those cases are rare in today’s environment.

NREB: Generally speaking, what are the most important upgrades/additions for each property type?

Rogers: There are too many factors to list. The most important factor is to evaluate each upgrade and addition for its return on capital. The one question that needs to be answered is “Does the upgrade increase my cash flow?” If so, what is the return on the investment? If there is a sufficient return, the upgrade will increase the asset value.

NREB: Any other recommendations for improving the value of commercial properties?

Rogers: Focus on cash flow. Focus on getting vacant spaces leased at a rate that is at least market with strong tenants. Look for ways to reduce operating expenses such as eliminating wastes and considering green technologies. Every upgrade or capital improvement needs to have a return on investment.

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