Was Anyone Really Surprised When Mr. Wallenda Fell?

Photograph by MoonSoleil/Conny Liegl

The Flying Wallenda’s were tightrope daredevils who performed without a safety net. Having perfected the 7 person human pyramid over 50 years of performing they became the most famous high wire circus act of the 20th century. In a 1963 performance two of the family fell to their deaths.

Some people were surprised.

In the middle of this decade the availability of no-doc, 45 year, 105 % cash back at closing, adjustable rate home loans made the market prices soar. Having perfected the art of packaging tens of millions of loans by stuffing in the junk with the good stuff, shares of junk bonds backed by homes spread all over the world. The American savings rate is down to zero.

In 2008 the realization dawned that this meant some people had “already sold their house to the bank” and they were “upside down”. Irrational panic followed and several large companies fell to their deaths.

Some people were surprised.

Human nature is to follow the lemming in front of you and don’t ask any questions. Safety in numbers. We have a media which tends to make news where there isn’t any. And don’t even mention talk radio. They would make you think the boom times were normal and would never end. Now we have gone the other way and are talking ourselves right off the cliff. You read stats saying this or that is “36% Down”. Of course it is, we were on an all time high. Now we are going down. It’s a simple rhythm, like the tide. Up then Down.

Some lost sight of cycle when it was at the top. Now they are losing sight of the cycle when it’s at the bottom. From Irrational Euphoria to sheer Adrenaline Panic.

Those of us beyond gen x and y have seen worse than this. What’s different this time is the media carnival overplaying the situation. Remember Y2K ? It was brought to you by the news media. Remember how they said the electricity, the banks and all computers would fail at midnight on December 31, 1999 ? Remember what happened ? Nothing. Next time you read a Newsweek comparison to the Great Depression keep that in mind.

We also remember Robert Vesco, Michael Milliken and the junk bonds, the crash of 1987, the crash of 1999 (most have forgotten that one) and of course the dip after 911. We are still here and those of us who didn’t try to perform the 7 person human pyramid on a tightrope are doing fine.

This is the prediction of a seasoned observer - the media that magnifies and spins so well will turn from obsessing on the negative to finding the positive some time after the new President gets in. They will fulfill their own prophecy which they spun before the election. We will rally, once again, as we always have.

Chuck Carey is the principal of Carey Commercial, a Hyannis, MA based business and investment property brokerage firm serving Cape Cod, MA. Through his more than twenty years of professional involvement in the local marketplace, he is widely regarded as one of a small number of commercial brokers offering the level of experience and pragmatic perspective clients require as they address the dynamics of changing market cycles.

Restaurants Get Needed Refill on Tax Break

The recently passed Emergency Economic Stabilization Act of 2008 included an extension of the accelerated depreciation allowance for qualified leasehold and restaurant improvements and for certain improvements to retail space.

The National Restaurant Association hailed the passage of this “side order” provision extending the current 15-year depreciation schedule for improvements made to restaurant buildings in 2008 and 2009, and for new restaurant construction in 2009. 

According to Dawn Sweeney, President and CEO of the National Restaurant Association. “A faster, more accurate depreciation schedule has a direct impact on a restaurant’s bottom line. By shortening the depreciation schedule to 15 years, Congress has given operators cash flow to reinvest in their businesses, allowing them to grow and add more restaurant jobs.”

Cape Cod Commercial Real Estate Prices and Assessments Inconsistent

Whether you are a buyer, seller, broker, banker, or appraiser no doubt the recent decline in Cape Cod commercial real estate sales has made pricing or valuing a property much more difficult. As we entrench deeper in the current market cycle, many practitioners needing a continuous finger on the pulse of prices and values will creatively apply alternative methodologies. In our market area, in lieu of an appraisal or other formal analysis the leading and most time honored proxy for real estate pricing or valuing is the property’s municipal assessment. 

I thought it would be interesting to see how this anecdotal alternative has measured up recently by comparing recent Cape Cod commercial property sale prices with their respective assessed value. The data sets included sales prices from 93 transactions completed between January 2008 and June 2008 and their Fiscal Year 2008 assessments. The properties sold were located throughout all areas of Cape Cod. This is what the analysis revealed:

• Nearly 30% of the recorded sale prices were below the assessed value and the remaining 70% were transacted at sale prices above the prevailing assessed value.
• In 17.4% of the transactions, the sale price and assessed value fell within 10% above or below 100% of the assessed value.
• Among all transactions, sale prices were on average 128.5% higher than the Fiscal Year 2008 assessments. The median was 120.5% higher.

As the analysis shows, property assessments are often an unreliable proxy for establishing a reasonable price or market value of Cape Cod commercial real estate. The analysis doesn’t suggest the assessments are flawed or established superficially. Additionally, assessing professionals I have encountered throughout the region are among the most astute, capable and concientious practitioners I have encountered in my 25 years in the real estate business. What’s more, assessed values are established for a unique purpose incorporating special criteria, specific time frames and statutory guidelines.

In a market cycle where the number of Cape Cod commercial property sales are trending down, price levels are in a state of flux and property assessments provide inconsistent guidance, where do we turn?

In short, I suggest doing what always produces superior results in a challenging market: adopt a back to the basics mindset where there is no substitute for well developed, comprehensive market intelligence and a willingness to devote more time investigating and truly understanding key market nuances.

 

 Joseph P. Egan is a MA Certified General Real Estate Appraiser with over 25 years of professional valuation experience. Through a specialization in commercial real estate and closely-held businesses, since 1991 he has completed over 600 appraisal, brokerage and consulting assignments concerning all types of commercial real estate assets and going concerns located on Cape Cod, Nantucket, and Plymouth County, MA. Clients served generally include attorneys, banks, corporations, developers, investors, and owners of closely-held and family businesses. Prior to relocating to Cape Cod, Joe worked in the New York Metro Area and throughout CT with leading regional and national appraisal firms such as Cushman & Wakefield. Please contact Joe here.

Using Rules of Thumb to Value or Price a Business - Salt to Taste

Rules of Thumb are either a single or tight range of multiples assigned to an income stream generated by a particular business. They are also available for just about any business and do vary from industry to industry.

Rules of Thumb should not be considered synonymous with transaction data points or multiples derived from specific transactions usually reported by a party involved in an actual business sale such as a business broker or other intermediary.  

Although there may be some limited exceptions, the fact is while easy to apply and understand, valuing or making a purchase offer on any business by relying on a Rule of Thumb is not a good idea. There are several valid reasons why:

• At best, a Rule of Thumb is an anecdotal average and if applied across the board it tends to penalize the best performing businesses and reward the poor performers.
• In a related sense, although some massaging may be attempted, Rules of Thumb are fairly static and do not go far enough in accounting for variations from business to business. Examples of these key variations may include differences in customer and employee loyalty, lease terms, location, cash flow trends, supplier relationships, the nature and quality of the FF&E, and barriers to entry.    
• Reliably developing the correct income stream to apply against a Rule of Thumb can be tricky. If this important task is incorrectly developed and the Rule of Thumb is subsequently applied, it could very well be equivalent to a double mistake.
• Ray Miles, the creator of the largest and oldest business transaction database and founder of the Institute of Business Appraisers suggests using a minimum of ten data points or transaction multiples in valuing a business under a Sales Comparison oriented approach. How convincing is that single Rule of Thumb or tight range looking now? 
• A certain mystery surrounds Rules of Thumb. For instance, like urban myths, who actually creates them and under what circumstances are they formulated (based on completed deals or general expectations, cash or seller financed transactions)? And how do Rules of Thumb stack up against empirical transactional data? 

Whether you are a business owner or looking to buy a business, no doubt somewhere along the line a Rule of Thumb or two will be placed on the table. If you are inclined to partake, just remember to reach for and apply a little salt.

Success Tip: Aim for the Center and Price it Right From the Start

Experts agree the single most important thing you can do before listing your commercial property for sale on the open market is this: price it right.

Here are three main reasons why: 

1. Even in real estate, first impressions are lasting. A smartly priced property will generate and maintain much more attention from the start.
2. A property priced too high often sends the wrong message, especially to a savvy buyer or cooperating broker actively seeking only sensible opportunities offered by serious sellers. The fact is most prospects initially operate in a cursory “know it when I see it” fashion and take then the time to dig deeper once their interested is piqued. Failing to develop the initial interest due to an unrealistic listing price could serve to make your listing a nonstarter.
3. Relying on a pricing strategy which employs a series of price reductions is generally not a good plan. To begin with, after each price change the task of making all interested parties (past and future) aware of the price change can be difficult. Multiple price changes can also send out the “only testing the waters” impression and that’s one fishing trip serious prospects are adept at avoiding. Lastly, many smart and well advised buyers routinely interpret successive price reductions as growing desperation on the part of the seller.

While not an exact science, setting your sights on the center of the pricing target is the best way to bring your commercial property to the market. For objective and reliable assistance in establishing a sensible list price for your commercial property and featuring your listing on CapeCodBusiness.com™, please contact me. Working together we can pool our resources and experience to help you get what you desire: getting to the closing table in the most optimum time frame with an agreement that makes good sense.

MIT Price Index for Commercial Properties Declines in Q2

Transaction sale prices of commercial property sold by major institutional investors declined 2.7 percent overall in the second quarter of 2008 with prices for office properties declining 5.5 percent, according to an index produced by the MIT Center for Real Estate.

The office sector encountered the largest drop in the quarterly transaction-based index (TBI) in a single quarter since 1994, following minor declines in the past two quarters. The decline reduces office property prices to their early 2007 level.

The 2.7 percent decline in the overall quarterly TBI means that prices for properties such as shopping malls, apartment complexes, office buildings and warehouses are now more than 9 percent below peak values attained in mid-2007.

Henry Pollakowski, MIT/CRE senior economist and co-director of the Center’s Commercial Real Estate Data Laboratory (CREDL), noted that the gap represents “an historically sharp disconnect” between supply and demand.

“This quarter shows the biggest pulling away of supply from demand since 1991 and the third greatest in the 96-quarter history of the index,” Pollakowski said. “The result of this ‘disagreement’ between property owners and would-be buyers is that the volume of closed transactions tracked by the index is down drastically, falling 47 percent from the last quarter of 2007 to the first quarter of 2008.”

The TBI tracks the prices that institutions such as pension funds pay or receive when transacting properties such as shopping malls, apartment complexes and office towers. The MIT Center’s TBI is based on prices of National Council of Real Estate Investment Fiduciaries (NCREIF) properties sold each quarter from the property database that underlies the NCREIF Property Index (NPI) and also makes use of the appraisal information for all of the more than 5,000 NCREIF properties. Such an index–national, quarterly, transaction-based and by property type–had not been previously constructed prior to MIT’s development of it in 2006. NCREIF supported development of the index as a useful tool for research and decision-making in the industry.

A Price to Pay for Too Much Focus on Price?

In navigating the cross currents of the Cape Cod commercial real estate marketplace it seems many commercial real estate participants are missing the big picture by focusing too much on price levels. Much like an adept physician seeking to develop a timely and supportable prognosis by probing, prodding and questioning a patient, reliably deciphering market factors requires looking well beyond the leading indicators or “gimmies” such as price levels. Along with the seasoned physician, this is where the commercial real estate market participant’s cognitive skill comes fully into play!  

Certainly recent prices paid for similar Cape Cod commercial properties will always be relevant indicators. However, the most important thing to remember about real estate prices — like cherished school photographs taken in early September and eventually passed on to relatives months later at Christmas – much can change in between! Since real estate transactions often take many months to consumate, report and be acknowledged by the marketplace much can and will change in between. It’s no wonder real estate prices are what economists call a classic lagging indicator. Couple this fact with the forward thinking and “not at real time” nature of real estate markets, the inherent limitations from an over reliance on price levels are apparent. 

In a market cycle where the number of commercial real estate sales are trending down, price levels are in a state of flux,  and the supply of available properties is abundant, it’s no wonder the real estate market is an imperfect marketplace.

But given the current scenario where do we turn, beyond price levels, for more answers in this imperfect or unstructured marketplace? In short, I suggest back going to the basics where greater reliance is collectively placed on four additional key market indicators:

1. Contract prices for properties currently under agreement.
2. Regularly updated figures on transaction volume with demand ranked by property sector.
3. Familiarity with sensibly priced comparable listings with a sharp focus on the number of days-on-market, any history of price changes, and possibly the number of showings and feedback.
4. Most importantly, obtaining from a reliable source the who, what, where, when, how and why surrounding any pending or closed transaction. Sources may include the Buyer or Seller, an attorney, broker, tenant or other party.  And in the current tight credit market, consider the perspective of a trusted local commercial banker to be invaluable.

Clearly seeing the big picture beyond price levels, understanding all the moving parts and applying sound investigative skills will separate you from the pack in the coming market cycle. Over reliance on one piece of information such as price levels is essentially reaching for the low hanging fruit and a sure sign of hanging on to 2004-2007 market thinking. The times (and the market), they are a changin!

 

 Joseph P. Egan is a MA Certified General Real Estate Appraiser with over 25 years of professional valuation experience. Through a specialization in commercial real estate and closely-held businesses, since 1991 he has completed over 600 appraisal, brokerage and consulting assignments concerning all types of commercial real estate assets and going concerns located on Cape Cod, Nantucket, and Plymouth County, MA. Clients served generally include attorneys, banks, corporations, developers, investors, and owners of closely-held and family businesses. Prior to relocating to Cape Cod, Joe worked in the New York Metro Area and throughout CT with leading regional and national appraisal firms such as Cushman & Wakefield. Please contact Joe here.

Survey Assesses Thinking and Strategies of U.S. Real Estate Professionals in Current Economic Climate

In Grant Thornton LLP’s 2008 Real Estate Survey, nearly six in 10 real estate executives (57%) have a pessimistic outlook regarding the U.S. economy for the next year, and almost half of the respondents (48%) have similar feelings about the real estate industry’s business outlook. These numbers show a sharp decline in optimism from 2006, when only 15 percent of respondents had a pessimistic outlook about the economy, and a scant five percent were pessimistic about the real estate industry’s outlook.

Despite these pessimistic economic and industry outlooks, respondents’ attitudes toward their own companies remain much more positive. Half of the respondents express an optimistic outlook for their own companies in the coming year, and only 12 percent had a pessimistic outlook. In 2006, 80 percent of respondents had a positive outlook for their own companies in the next year.

When asked about the single most important issue facing their industry in the next year, more than one-third of real estate executives (36%) chose the national economy. Other concerns included earnings and operation results (21%), the ability to access capital (19%), tenant relationships (10%), and rising costs (5%), among others. 

Survey respondents also weighed in on anticipated rate changes in the market. These are some of the predicted rate changes in the coming year:

• 69 percent think the unemployment rates in their market will increase.
• Three-fifths (61%) predict vacancy rates will rise in their market.
• 79 percent of respondents expect capitalization rates to increase nationally.
• 76 percent believe the capitalization rates will increase in their market.
• Half of respondents (51%) think interest rates will decrease.

Survey respondents are focused on a wide range of issues and strategies, including:

Grant Thornton LLP’s 2008 Real Estate Survey was designed to elicit the opinions and activities of a broad range of real estate industry professionals. The real estate executives were polled in two ways. First, an invitation to participate in the online survey was sent to nearly 1,900 real estate contacts in Grant Thornton’s database. This effort was followed up with a communication to 4,000 developers, owners and investors who are members of the National Association of Industrial and Office Properties (NAIOP). NAIOP’s members include developers, owners, investors and other professionals in the industrial, office and mixed-use real estate industry. A total of 341 survey responses were collected between March 2, 2008, and March 26, 2008.

Respondents of the survey described themselves as developers (41 percent), real estate investors (17 percent), real estate owners (11 percent), and asset managers (9 percent). Others included real estate property managers (5 percent) and construction contractors (1 percent).

Grant Thornton LLP is the U.S. member firm of Grant Thornton International Ltd, one of the leading global accounting, tax and business advisory organizations. Visit Grant Thornton LLP at www.GrantThornton.com.