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Sunday, November 15, 2015

The dangers of appraising properties in a vacuum

When we were in school and before a scheduled exam, we had two choice to prepare. We could either  study the principles required to pass the exam, or we could simply copy the answers off our fellow student's test paper. If the latter was your strategy, you had to make sure you sat next to the student that had the greatest chance of passing the exam. After selecting your fellow student and coping his test answers, what if you were unaware he to had copied his answers from another fellow students test paper.

This is essentially how real estate appraisals are still being conducted today. It is still acceptable for an appraiser to simply use recent comparable sales in comparing to his subject property in order to arrive at the property's current market value. The most competent appraiser will research the market and find the most recent and similar comparable sales in arriving at subject's current market value. These type of sales will give a third party reader of the appraisal report the most confidence in the appraiser's final opinion of value. But what if this current market value is laced with the market's "irrational exuberance" (will explain later).

This traditional "sales comparison method" worked very well in the twentieth century until the late 1960's and early 1970's. Before these decades, property values were relatively stable and coincided with economic fundamentals (property users demographic personal and business income that translated into what they could reasonably pay in terms of rent for the specific property). For example, in years prior to these decades, the typical demographic for a specific residential neighborhood might have had a household income of say $20,000 annually. Back then, approximately 30% to 35% of this income was first used for housing costs. This housing cost potential translated into the value of houses in that neighborhood. The relationship of the housing cost potential (or rent) and the risk of single family housing to an owner/user or investor created the property's market value. If this value coincided with the property's economic fundamentals, the market value had a greater chance of sustainability during a typical ownership holding period.

From the early 1970's forward, property values have escalated at an unprecedented rate mainly as a result of expanding demographic personal household/business income from owners and users of these properties. However, the market still assumes comparable sales have the same economic fundamentals associated with the comps sale price as it was pre-1970.  We have learned this is not always the case as we saw in the mid to late 2000's "Great Recession".

By continuing to "copy off our fellow students test paper" in predominately using the sales comparison appraisal methodology, we have learned that comparable sales prices can be laced with "irrational exuberance" by the faulty forecasts of the collective market participants. These faulty forecasts move the sale price of the comparable sale away from the property's economic fundamentals adding greater risk of the sale price not being sustainable during a typical ownership holding period.  These faulty forecasts generally revolve around expectations of what a property will sell for at the end of an ownership holding period and/or an unsustainable percentage of the property user demographic personal/business income used as an estimate of the property's "market rent".

Consequently, the users of valuation products are demanding more than a single-point-in-time market value estimate that is derived from comparable sales or other methodologies using current market data and units of comparison. They want two other bits of information after the appraiser has expressed his opinion of the subject's current market value. First, they want to know the forecasts or "bets" associated with the appraiser's current market value and Second, they want to know how far, if any,  the appraiser's current market value has detached from the property's current fundamental value (sometimes called intrinsic value). These two added bits of information will flush out any hidden risks of whether or not the appraiser's current market value opinion is sustainable during a typical ownership holding period.

The widespread use of the new valuation tool call Valuexpose is specifically answering these two bits of information the market is demanding. Once the appraiser formulates his opinion of a property's current market value (either residential or commercial), this value can be inserted into Valuexpose indicating all the forecasts or "bet" associated with the property's current market value. In addition, Valuexpose will also compare the current market value to the property's current fundamental value indicating whether or not the subject's current market value is sustainable during a typical ownership holding period. If a property's current market value is not sustainable, Valuexpose will indicate whether it is due to irrational forecasts of the property's ending sale price at the end of the ownership holding period and/or whether or not the current forecasted market rent for subject property is outside the typical percentage range a user can afford to pay.  If the demographic that typically uses the subject property is paying too much of its personal/business income for rent, the subject's current market value could be artificially inflated and also unsustainable.

Continuing to appraise properties in a vacuum and not indicating the additional bits of information the users of valuation products are demanding will certainly lead to more and more severe bubbles that will cost individuals and our nation trillions of dollars of unnecessary losses now that we have advanced valuation tools.


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Sunday, October 18, 2015

How To Jump Start Commercial Real Estate Agents Expertise

Make no mistake about it, commercial real estate agents and brokers are hired for their expertise. Trying to "fake it until you make it" is a prescription for a fast burnout in this competitive business. The fundamental expertise clients are expecting from you regarding their property is where its current market value lies in the market place for their particular property type. They want to know that you can convince either the buyer or seller that your value opinion expertise and arguments are in line with the market's expectations.

Commercial property is not homogeneous.  Simply using comparable sales in trying to "eyeball" where the client's property value should lie does not distinguish your expertise from all the other commercial real estate agents. If fact, comparable sales are less and less relevant if the your clients property is currently not at its highest and best use, for example:
  • NON-STABILIZED PROPERTIES
  1. Current leases are currently below market rent
  2. Current occupancy is below stabilized occupancy 
  3. Or both
  • PROPERTY IS NOT FINISHED OR NEEDS MAJOR REMODELING 
  1. Currently, the property is unfinished possibly due to financial hardship
  2. Property might be older and needs major remodeling 
An expert commercial real estate agent would not use recent sales of stabilized properties, that were sold at their highest and best use, to compare to your clients property that is currently NOT at its highest and best use. Nor would an experienced agent try to use other property sales that were not at their highest and best use at the time of sale. For these type of sales to be relevant, their physical and economic condition would have to be very similar your client's property (if you can even find these kind of sales).

Depending on the client property's circumstance, an experienced and expert commercial agent would first determine what the client property's highest and best use will be once the above bullet points are corrected. If the property is below market rent, how long will it take a new buyer to bring the rents up to market? How long will it take to bring the property to stabilized occupancy? What are the costs and timing to remodel the property to its highest and best use?

Traditionally, this is outside the expertise of most commercial agents due to the complexity of creating generally accepted financial DCF models (discounted cash flow models) that take into consideration all of the costs and risks associated with this type of property. The result of this analysis will give the client an opinion of the property's current "as is" market value and what the client can expect the property to sell for in the market place. 

Valuexpose software now bridges this expertise gap by giving the agent the tools and graphic reports to easily perform this type of analysis and impress the client with his expertise in arriving at the property's current "as is" market value opinion. No more guessing at what the "discount" will be from the property's stabilized value in trying to advise your client as to what the property's "as is" value opinion might be. Valuexpose will easily explain to you and your client what the property's current "as is" value must be when the property is brought up to its highest and best use by a new buyer. 

If the property needs major remodeling to achieve its highest and best use, Valuexpose even explains if the proposed improvements are financially feasible (go or no go). This will help the agent advise the property owner or buyer if the proposed improvements are over improving or under improving the property resulting in not achieving the property's highest and best use. It will even support the agents opinion of who the market will be for the property (developers or land speculators).

If you would like to see how Valuexpose handles these situations, you might want to go to this link to see a case study on a property that needs major remodeling (Module 3). This analysis show you and your client what the current "as is" value opinion should be for this property as well as other vital information.

For properties at non-stabilized occupancy due to currently being leased at below market rent or at below stabilized occupancy, Valuexpose uses Module 4 to analyze these properties (see "Why Valuexpose" on home page).

By incorporating Valuexpose reports and graphics in your listing and selling presentations, you will jump start your reputation as an expert in your property specialty no matter what the property's current physical or economic condition.

My next blog will show you how Valuexpose can be used to value your property type's vacant site before the building is constructed. This analysis will show what the site's current "as is" value is based on the site's highest and best use as well as other vital information that highlights your expertise. 















Tuesday, August 25, 2015

Case Study - A multi-family complex to be remodeled (Module 3)

Your client is purchasing an average quality 20 unit garden type apartment complex that needs major remodeling due to its current age and poor condition. Total gross square footage for the complex is 17,700 SF on a 70,800 lot. The complex has seven studios, seven 1-bedrooms, and six 2-bedrooms units. Tenants pay their own personal gas, water, and electric utilities. Your contractor has quoted you direct costs of $12,500 per unit or $250,000 and $10,000 in landscaping and pool upgrades. 

The contractor estimates the total completion of this remodeling job will take 4 months. The contractors fee to complete this job is $35,000. After the remodeling is complete, your rental survey indicates market rents will be $750/month for the studios, $1,080/month for the 1-bedrooms, and $1,380/month for the 2-bedrooms. Once remodeling is completed, it is expected to take 8 months to reach stabilized occupancy at 5% vacancy and collection loss.  Market rents are expected to increase 2% annually during a typical seven year ownership holding period. During the remodeling phase, existing tenants are expected have a 2% collection loss. Other monthly income includes $20/month per occupied unit for laundry; $10/month late fees per occupied unit; and $10/month other income per occupied unit.





Based on the owners coordination and planning expected to take in organizing the project and implement the remodeling, the owners entrepreneurial profit expectation is $35,000. In addition, the effort or cost the owner will incur in leasing the remodeled complex back to stabilized occupancy is expected to add another $25,000 in entrepreneurial profit.


Ten units are currently rented at an average rent of $750 per unit. The remaining 10 vacant units will be remodeled first taking four months to complete. Seven of the 10 existing tenants have agreed  to move into the newly remodeled finished units. Remodeling the remaining 10 units will take another four month. During this time, you have agreed to keep the 7 remaining tenants average rent at $750/month per unit. Once the final ten units are complete, all rents, including the 7 transplanted tenants, will accelerate to market rents as outlined earlier.


When remodel is 100% complete and at stabilized occupancy, variable expenses are estimated as follows:

1.      Off-site management costs: 4% of gross income collected (even if the owner manages the
      complex himself)

2.   Landlord’s average natural gas monthly expense (mainly house meter and vacant units):
      $50/month total landlord’s cost.

3.   Landlord’s average electric monthly expense: $200/month

4.   Landlord’s average sewer/water expense: $100/month

5.   Landlord’s trash removal: $50/month

6.   Landlord’s interior cleaning expense: $150/month

7.   Landlord’s landscaping expense: $300/month

8.   Landlord’s average maintenance and repair expense: 4% of gross income collected

9.   Landlord’s pool expense: $150/month

10. Landlord’s pest control: $50/month

11. Landlord’s advertising expense: $75/month

12. Landlord’s legal/accounting expense: $100

13. Other monthly expenses: $100/month

14. Variable expenses are expected to increase an average of 2% annually for the next 7 years.



When remodel is 100% complete and at stabilized occupancy, fixed expenses are estimated as follows:

15. Estimated property taxes when complex is 100% remodeled is estimated at $31,250/year

16. Property taxes during the construction and lease-up timeframe are going to be $18,750/year

17. Fire and Liability insurance when complex is 100% remodeled are going to be $3,500/year

18. Fire and liability insurance during the construction is $2,500/year

19. Fixed expenses are expected to rise 2% annually during the next 7 years.



When remodel is 100% complete and at stabilized occupancy, reserves and replacement expenses are estimated as follows:

20. Carpet and drapes: $2,500/unit (8 year life)

21. Disposials: $250/unit (8 year life)

22. Refrigerators: $1,500/unit (8 year life)

23. Stoves: $1,500/unit (8 year life)

24. Microwave: $500/unit (8 year life)

25. HVAC short lived items: $2,500/unit (8 year life)

26. Roof cover per unit: $3000/unit (20 year life)

27. Dishwasher: $1,500/unit (8 year life)

28. Other: $500/unit (8 year life)




Based on the risk to remodel and lease to stabilized occupancy, an owner/remodeler would expect a 9% all cash annual yield on his invested cash in the project (not including his entrepreneurial  profit expectation) and an opportunity cost of 2%. Current cap rates from sales of similar remodeled properties are 6%. This “going in” cap rate is estimated to be applicable to subject “going out” cap rate when the property is 100% remodeled and at stabilized occupancy in the next 12 months. From that point forward, the owner would expect a 7% all cash annual  yield based on alternative investments with similar risks. This annual yield includes the final selling price recapture at the end to a seven year typical ownership holding period. The owner is expecting a 6% selling cost.



Once property is 100% remodeled, there is estimated to be approximately $100/month in “below the line leasing expenses” from outside leasing agents in order to achieve stabilized occupancy. This monthly expense is not expected to continue after stabilized occupancy is achieved.


How to input this data into Valuexpose…..

1.       In your user dashboard select “Create new project”

2.   In the decision tree select:

       a. Property WITH reversion
       b. Residential classification
       c. Existing or proposed multi-family dwellings
       d. Garden/Low Rise
       e. Average Quality
       f. Module 3 - Partially Finished or Needs Remodeling (Might have existing income)

3.   Fill out the wizard questions with the above case study data and hit the finished button.

4.   The timeline shows your client should not pay more than $1,878,744 (see left side of the timeline graphic) if his wizard question forecasts are to be achieved. The right side of the timeline indicating $2,528,088 is what the complex is expected to sell for in 8 months when the complex is 100% remodeled and at stabilized occupancy.  The middle value on the timeline of $2,258,501 is the 100% complete non-stabalized value before the complex reaches stabilized occupancy. This value is used to compare to the subject’s cost of production which is the value of $2,211,017 directly above the non-stabilized value on the timeline. If the non-stabilzied value of $2,258,501 is equal or greater than the cost of production of $2,211,017, then the project is considered financially feasible to begin the remodeling project. Due to this relationship, notice this proposed remodel is economically feasible as indicated by the green highlighted context above the timeline.


5.   Now press the “Economic Fabric Graph” (button on the upper right hand side of the timeline
graphic page). This EFG graphic shows the subject’s 100% complete market value of 
$2,528,088 at stabilized occupancy (right hand side previous timeline value as of the 
stabilized completion date of 8/7/16). In order for the owner to achieve a 7% annual yield during the 7 year ownership holding period, the property must have an ending sale price of $2,798,486. These two EFG timeline values are superimposed together with the subject’s current fundamental/intrinsic value of $2,471,960 and its ending sale price of $2,702,604.


6.  In the upper right hand corner of the “Economic Fabric Graph” (EFG), press the “Show Market Cycle Button” to overlay the economic wave cycle. In this particular scenario, the wave cycle is indicating the subject’s remodeled sale price of $2,528,088 is sustainable during a typical seven year ownership holding period. This means the remodeled sale price/market value is reasonable and aligned with the property’s economic fundamentals values. Based on the property’s completed market value of $2,528,088, the market is estimating the property will sell for $2,798,486 to achieve a 7% annual yield. At the same time, the property’s fundamental/intrinsic completed value of $2,471,960 must sell for $2,702,604 also achieve a 7% annual yield. Both of these ending value targets are above the subject’s completed market value of $2,528,088. Consequently, the subject’s completed market value of $2,528,088 is sustainable over the seven year holding period.   

Please note you will find on the right hand side of the EFG graph the annual household income of $43,780 needed from each tenant to pay the average $1,095/month market rent. Consequently, the household family income needed to pay the average market rent indicates 30% of the household income. For the subject’s neighborhood, $43,780 annual household income coincides with the demographic households that occupy dwellings in this neighborhood (Can check census data at http//eddm.usps.com to validate neighborhood’s household income). This household annual income and ability to pay $1,095/month average rent coincides with the subject’s current remodeled market value of $2,528,088 which further coincides with the subject’s fundamental/intrinsic current value of $2,471,960. In both cases, the remodeled market value of $2,528,088 and its ending sale price of $2,798,486 as well as the fundamental/intrinsic current remodeled value of $2,471,960 and its ending sale pice of $2,702,604 both produce a 7% annual yield rate (present value of net rental annuities plus net ending sale price reversion after selling expenses are deducted). This 7% annual yield rate is what the market is expecting if investing in the remodeled property (see original forecasts in this case study).



7.   While still in the EFG graphic, press the timeline button in the upper left hand corner and go back to the remodeling timeline. Let’s say the market supports a cap rate of 4% based on  recently sold remodeled apartment complexes (we initially indicated a 6% cap rate in our original scenario). This lower cap rate is possibly due to an increase in demand for properties like the subject. Scroll down from the timeline graphic to the grouping box labeled “Rates and Other Information”. The first questions has to do with a forecast of what the subject’s going out cap rate will be. In our first scenario, we used 6%. In this scenario, let’s use 4% and substitute the 4% for the 6% in the adjacent box. Now press the “update” button at the bottom of this grouping to recalculate the remodeling timeline values.


8.   In the revised timeline values, notice the 100% remodeled complex at stabilized occupancy has changed to $3,792,133 (right hand side of timeline). Also, this new finished value has changed the other values above and below the timeline. The potential remodeler can now reasonable pay $2,965,043 for the “as is” property (the far left side value of timeline). You also might notice the project is still economically feasible at the “as is” value of $2,965,043.  


9.   Now press the EFG button on the upper right hand corner of the timeline graphic. Notice the subject’s $3,792,133 finished market value has detached 53.41% above the property’s fundamental/intrinsic finished value ($2,471,960).


10. Now press the “show market cycle” button in the upper right hand corner of the EFG graphic page. This resulting graphic overlay indicates the finished market value of $3,792,133 is not sustainable over a typical seven year ownership holding period. The reason being the $3,792,133 finished market value is not sustainable is because over the seven year ownership time period the value of the property tends to gravitate towards equilibrium or the fundamental/intrinsic ending value of $2,702,604.                  


Also notice on the right side of the EFG model the household annual income of $67,161 is needed to support a sale price of $3,792,133. This household income is above the demographic income of $43,780 associated with the subject’s $2,471,960 fundamental/intrinsic finished value.      

Lastly, notice in both these scenarios the $3,792,133 current market value and its needed ending sale price of $4,957,825, and the $2,471,960 current fundamental/intrinsic value and its ending sale price of $2,762,604 both have 7% annual yield rates (or discount rates) during the seven year ownership holding period. Consequently, the market is irrationally speculating on the property’s ending sale price of $4,957,825 that would need an annual household income of $87,806 to support this ending sale price. If Valuexpose was available for this scenario, the user of this software would have been aptly warned as the subject’s remodeled market value of $3,792,133 has significantly detached from its remodeled fundamental/intrinsic value of $2,471,960 and this value is not sustainable over the seven year ownership holding period. The remodeled $3,792,133 value will most likely gravitate toward the fundamental/intrinsic ending sale price of $2,702,604 during the seven year ownership period. This scenario will lower the subject’s expected annual yield of 7% to minus 0.38% (scroll down from EFG graphic to see this yield difference). 


11. Valuexpose also indicates buyer opportunities. For the same property example, let’s say well supported cap rates indicates a 7.5% for recent sales of remodeled properties similar to the subject. Once again, go to the timeline graphic and scroll down to the grouping labeled “Rates and Other Information”. Substitute 7.5% into the first answer box for the first question regarding going out cap rates and press the update button.


12. In the revised timeline values, notice the 100% remodeled complex at stabilized occupancy has changed to $2,022,471 (right hand side of timeline). Also, this new finished value has changed the other values above and below the timeline. The potential remodeler can now reasonably  pay $1,444,224 for the “as is” property (the far left side value of timeline). You also might notice the project is still economically feasible if the property can be purchased at the “as is” value of $1,444,224. This is because the remodeled value at non-stabilized occupancy ($1,810,798) is greater than the cost of production ($1,773,600).



13. Now press the EFG button on the upper right hand corner of the timeline graphic. Notice the subject’s $2,022,471 finished market value has detached -18.18% below the property’s fundamental/intrinsic finished value ($2,471,960).


14. Now press the “show market cycle” button in the upper right hand corner of the EFG graphic page. This resulting graphic overlay indicates the finished market value of $2,022,471 is sustainable over a typical seven year ownership holding period and will most likely gravitate  toward the fundamental/intrinsic ending sale price of $2,704,604 over the course of a seven year ownership holding period. On the right side of the EFG model the household annual income of $35,019 is needed to support a sale price of $2,022,471 which is well below the family income that occupy apartments in this neighborhood. ($43,780).



15. Also notice in both these scenarios the $2,022,471 current market value and its needed ending sale price of $1,934,791 and the $2,471,960 current fundamental/intrinsic value and its ending sale price of $2,702,604 both have 7% annual yield rates (or discount rates) during the seven year ownership holding period. Consequently, the market demand for this property is below normal and represents a buying opportunity. If the property’s finished market value of $2,022,471 gravitates toward the fundamental/intrinsic ending value of $2,702,604, the owners annual yield will be enhanced from 7% to 10.77%. If Valuexpose was available for this scenario, the user of this software would have been alerted to a very good buying opportunity.


16. The above demonstration shows you how Valuexpose isolates a property’s finished fundamental/intrinsic value from whatever the property’s finished market value happens to be as of the same date of value. This new category of valuation analysis prevents you from making critical decisions in a vacuum based on the traditional single-point-in-time appraised market value. Comparing finished market value of a property to its fundamental/intrinsic finished value flushes out hidden risks.

17. For properties, like this example, that need to be remodeled or developed from scratch, Valuexpose has another valuable feature that will prevent the premature start of a project if Valuexpose indicates the proposed remodeling or development is not economically feasible to begin right a way. For instance in our last example timeline indicated the current “as is” value (before remodeling) of $1,444,224. However, lets say the seller wants $1,900,000 for his property. On the left side of the timeline underneath the far left value is a button labeled “input your value”. Simply press the button and insert the seller’s asking price of $1,900,000 in the pop-up window and press “update” button.



18. Notice the proposed remodeling project is not economic feasible because the Cost of production value is higher than the 100% remodeled property at non-stabilized occupancy. Valuexpose substitutes the $1,900,000 asking price into the cost of production instead of the $1,444,224 “as is” value Valuexpose was indicating what you would have to buy the property for to be economically feasiable. If the analysis is indicating the project is not economic feasible, Valuexpose allows you to determine when the market is forecasting the time will be right to begin the remodeling process.

19. Let’s assume the seller’s $1,900,000 “as is” market value is correct and can be sold to a speculator at that price based on recent comparable sales. Upon further investigation, it is determined market rents for our remodeled property are not achievable in the foreseeable future due to negative job market and high unemployment. Because a buyer is going to have to hold and manage the property in its “as is” condition until the job market improves, he will incur more risk during the holding period because of unknowns. Consequently, lets go to the “Rates and Other Information” grouping box below the timeline graphic. Let’s substitute the third questions of 9% to 13% for increased risk due to holding the property. Press update button.


20. When the analysis indicates the remodeling project is not economically feasible, a button will appear on the upper left side of the timeline graphic labeled “add holding period”. Pressing this button will indicate a pop-up window to insert the number of months the market expects it will take before market rents are high enough and lease absorption is fast enough to begin the economically feasible remodeling process. In the case of our subject property, the market is expecting a two year hold before it becomes economically feasible to start the remodeling project. This means you will be delaying the delivery into the marketplace by two years the finished remodeled property at stabilized occupancy. Consequently, in the pop-up window insert 24 months and press the process button.



21. You are delaying the start of the remodeling project by two years in an effort to deliver the finished property into a market that has normalized. Like the first scenario we used in the beginning of this case study, a normalized market for this property indicated a 6% cap rate for our remodeled property. Scroll down from the timeline to the grouping “rates and other information”. Change the “going out” cap rate from 7.5% back to 6%.


22. Before you can see the recalculated timeline values, you must now eliminate the owners asking price of $1,900,000 that is appearing on the timeline. Simply press the “remove/update your value” button and toggle to “no” in the pop-up window and press the “update” button. Once recalculation is complete, notice the remodeled and stabilized market value of $2,528,088 is indicated on the right hand side of the timeline. This will be the subject’s finished market value if you are delivering this product into the marketplace two years later due to your holding period. By deliberately delayed the remodeling for two years anticipates a more normal market if you delivered the remodeled property two years earlier. The revised timeline values indicate the “as is” value of $1,525,955 on the left side of the timeline.
      This is the value you should pay for the property in order to achieve a 13% annual yield if you sell the property in two years. If you decide to proceed with the remodeling project yourself, your annual yield will be 13% for the first two years of ownership (holding period) and 9% annual yield until the property is complete and at stabilized occupancy. If you further decide to hold the remodeled property as an investment for a typical seven year ownership holding period, your annual yield for this time period will be 7%.   


23. The trick to giving you confidence the $1,525,955 “as is” market value (with a two year holding period) you are paying for the property is a fair price is decided by the $2,528,088 remodeled market value expectation. By pressing the EFG button on the timeline graphic, you can see the $2,528,088 remodeled market value is very close to the property’s fundamental/intrinsic remodeled value. Consequently, the $2,528,088 remodeled market value is sustainable and so is your $1,525,955 purchase of the “as is”.




24. Let’s say the current owner of the property insists the “as is” value of his property is $1,900,000. To test if this is a fair price, go back to the timeline graphic and scroll down to the grouping labeled “rates and other information”. Start testing lower “going out” cap rates by pressing this grouping’s update button after each cap rate change. Do this until the timeline “as is” value equals $1,900,000 (the owners asking price). In this case, the revised going out cap rate is 4.87%. Notice this revised cap rate increases the remodeled market value (right side of the timeline) to $3,114,688 which in turn increases the “as is” market value to $1,900,000 (+ or -).




25. To see if the $1,900,000 asking price is reasonable, simply press the EFG button on the upper right hand side of the timeline graphic. You can see the $3,114,688 remodeled market value has detached 26% from its fundamental/intrinsic remodeled value. This means the $3,114,688 finished market value is not sustainable and that you are paying too much for the current “as is” market value at $1,900,000.




26. We are currently working on a report you can print out for Modules 3 remodeling projects. In the meantime, and as an alternative, you can input the same data in a Module 5 for multi-family property types based “as if” your property were already remodeled and at stabilized occupancy. From the module 5 model, you might want to print out two versions based on the remodeled value of $2,528,088 and the $3,114.688. The report based on the $2,528,088 remodeled value will show the property owner this value is sustainable which would support your offer os $1,525,955. The other report based on the $3,114,688 remodeled value indicates this value is not sustainable and would not support his $1,900,000 asking price. This is a wonderful tool to bring a sellers and/or buyers price expectations in line with the market.

27. The above demonstration shows you how Valuexpose isolates a property’s remodeled fundamental/intrinsic value from whatever the property’s remodeled market value happens to be as of the same date of value. This new category of valuation analysis prevents you from making critical decisions in a vacuum based on the traditional single-point-in-time appraised market value. Comparing current market value of a property to its fundamental/intrinsic value flushes out hidden risks.

28. There are other important analysis features associated with multi-family properties that need remodeling. Getting back to our example, go to the timeline that shows the last “as is” market value at $1,900,071 with a holding period. Scrolling down from the timeline graphic shows all the components of value (or forecasts) associated with this property for its current “as is” market value to equal its $1,900,071. Notice in each grouping you can change forecasts within that grouping. You must push the “update” button for that grouping after you have changed any of the forecasts in that grouping. Any changes to other groupings must also hit the “update” button for that grouping before you proceed to the next grouping changes. Once all forecast changes in each grouping have been made and updated, notice that Valuexpose has recalculated your $1,900,071 market value (or sale price) as well as all the other values along the timeline graphic.

29. One limitation you might notice when changing forecasts pertaining to average forecast changes in annual market rent is that the percentage changes to your property’s market rent cannot be less than the annual percentages indicated in the fixed and variable expense groupings. We are working to solve this limitation.

30. Another important analysis feature is adding financing (or leverage) to the analysis to find the optimal annual equity yield. Using our former example based on a $1,525,955 “as is” market value, let’s analyze a loan of $800,000 at 3.5% fixed annual interest including $2,500 in closing costs. First change the cap rate in the “rates and other information” grouping from 4.87% to 6% to return the timeline value of $1,525,955. Underneath the timeline graphic press the button labeled “Remove/Update Financing”. Fill in the pop-up window with the above financing information and hit the “update” button. Valuexpose then recalculates and indicated the property’s equity yield displayed to the immediate left of the “Remove/update Financing” button. In this scenario, the equity yield indicates 18.65% (this result might be a little different if you changed some of the original forecasts in the forecast groupings below the timeline). You can continue testing different financing scenario to find the optimal equity yield before a subsequent financing scenario results in a declining equity yield rate. If the financing scenario results in a negative equity yield rate, Valuexpose will show “Caution”.


31. Unlike most valuation software, Valuexpose provides all Discounted Cash Flow (DCF) analysis for all value results. On the left side of the timeline graphic (underneath), you will see buttons labeled “DCF as is” and “DCF as is-financed”. Pushing these buttons displays the customized intricate DCF models so the user can verify the value results. You will also see DCF buttons underneath other values on the timeline.

32. Another interesting analysis feature is being able to access the property’s ending stabilized income and expense statement used to calculate the property’s annual net operating income. You will find a button on the right side of the timeline graphic labeled “stabilized operating statement”. Pressing this button provides you with the stabilized income and expense statement.

33. Once you have completed your analysis on your particular property and are satisfied with the results, scroll down underneath the timeline graphic to see the “units of comparison” grouping. This grouping box summarizes all the metrics associated with your property.


34. The above demonstration represents only one real estate classification (residential), one property type (Multi-family), and one “state of its building existence” (partially complete and/or needs remodeling). Valuexpose can analyze 13 different real estate classifications (ex. residential, retail, industry, office, etc.) that include a potential of 320 property types; each in five different states of building existence (100% complete stabilized; 100% complete at non-stabilized; partially complete or needs remodeling; and properties that are to be developed with and without entitlements.

35. Valuexpose is the first patent pending commercial automated valuation model (AVM) that uses comparable sales with very similar highest and best uses located in markets that are similar to the subject’s market. Valuexpose uses the comparable sale properties components of value forecasts (that make up their sale prices) to value the subject properly if its value is unknown. Now dozens if not hundreds of comparable sales can be automatically used to value your property’s current market value. This gives a more accurate valuation than the traditional comparable sales analysis that is time consuming, expensive and potentially biased.  This new category of valuation analysis further eliminates appraisers logic inconsistencies and incompentency problems due to lack of experience. All valuation results are compared to the property’s fundamental/intrinsic value to flush out hidden risks and keeping you from making important decisions in a vacuum.

36. Valuexpose financial reporting option allows the user to initially analyze portfolios of properties on a property-by-property basis. The user can set Valuexpose to update any or all of the properties in the portfolio to update each property’s current market value on a daily, monthly, semi-annual or annual basis (or anything in-between). This analysis feature will also track the relationship of a property’s current market value with its fundamental/intrinsic current value. This relationship tracking will give the user a better strategic management and exit advantage.

37. If you would like to see another case study on a different property type and/or in a different state of existence (existing building or to be developed/remodeled), you can personally call the founder Ray Dozier, MAI at (760) 413-5011 for a demonstration. 

Sunday, August 16, 2015

Case Study - Existing SFR ready to occupy (Module 5)

VALUEXPOSE INC.

Case Study - Existing SFR ready to occupy (Module 5)


Your client is purchasing an average quality move-up house for $526,000 as of the current date. The house is 2,600 SF on a 10,000 SF lot with a private pool. The new owner’s property taxes well be $4,600/year. The fire and liability insurance is estimated to be $1800/year. These two fixed expenses are expected to increase 2% annually during a typical seven year ownership holding period. Although the new owner plans to occupy the house, he has determined the house would rent for $2600/month on a longterm lease of one year or more if he decided to lease instead of buying the house. This monthly rent is expected to have an average increase of 2% annually. Based on this annual rental, it is customary in the neighborhood the landlord pays for the pool service of $100/month and gardener at $300/month. In addition, it is estimated the landlord will have an average of $75/month in maintenance and repair costs over his ownership holding period. These variable expenses are expected to increase 1.5% annually. Lastly, the landlord will also pay the annual taxes and insurance.

How to input this data into Valuexpose:

1.      In your user dashboard select “Create new project”

2.   In the decision tree select:

       a. Property WITH reversion
       b. Residential classification
       c. Existing or proposed single family Dwelling
       d. Move-up home
       e. Average Quality
       f. Module 5 - At stabilized Occupancy and Market Rents (Stabilized)

3.   Fill out the wizard questions with the above case study data and hit the finished button.

4. The timeline shows your client’s $526,000 current sale price (some small rounding       differences) on the left side of the timeline. The right side of the timeline indicates what the       house is expected to sell for at the end of a typical seven year ownership holding period.  This ending sale price (or reversion) is what the market is forecasting as of today’s date based on the $526,000 current sale price. Consequently, Valuexpose calculates the present  
value of the owner benefits (rental income benefit is equivalent to owner occupied benefits) during a seven year ownership holding period. In order for the present value to equal $526,000 current sale price, the ending sale price must be $566,765 based on a 4% annual  unleveraged annual yield (Valuexpose presets this yield for only the SFR property type based on historical trends).


5.   Now press the “Economic Fabric Graph” (button on the upper right hand side of the timeline
graphic page). This graphic shows the subject’s current sale price of $526,000 together with what the ending sale of $566,765 that must be based on the current sale price. This timeline is super imposed over the subject’s fundamental/intrinsic current value and ending sale price value for this property. You can see the subject’s current selling price of $526,000 is very close to its fundamental value of $527,999. Also, the subject’s ending sale price of $566,765 attributed to its current sale price is very close to the subject’s ending sale price ($565,423) attributable to the subject’s fundamental current value.


  
6.  In the upper right hand corner of the “Economic Fabric Graph” (EFG), press the “Show Market Cycle Button” to overlay the economic wave cycle. In this particular scenario, the      wave cycle is indicating the subject’s current sale price of $526,000 is sustainable during a      typical seven year ownership holding period. This means the current sale price/market value     is reasonable and aligned with the property’s economic fundamentals. Please note you will     find on the right hand side of the EFG graph the annual household income of $109,200     needed from a tenant/owner to pay the $2,600/month market rent (market rent is increased 5% in the DCF model for pride of ownership benefits for most, if not all SFR’s). Consequently, the household family income needed to pay the market rent (plus 5%rent bonus for pride of ownership) indicates 30% of the household income. For the subject’s neighborhood, $109,200 annual household income coincides with the demographic households that occupy dwellings in this neighborhood (Can check census data at http//eddm.usps.com to validate neighborhood’s household income). This household annual income and ability to pay $2,600/month rent (plus 5% more for pride of ownership benefit) coincides with the subject’s current asking price/market value of $526,000 which further coincides with the subject’s fundamental/intrinsic current value of $527,999. In both cases, the asking price of $526,000 and its ending sale price of $566,795 as well as the fundamental/intrinsic current value of $527,999 and its ending sale pice of $565,423 both produce a 4% annual yield rate (present value of net rental annuities plus net ending sale price reversion (after selling expenses are deducted).


  
7.  Now, let’s go back to the timeline graphic by pressing “timeline” button on the upper left hand corner of the EFG graphic page. Let’s pretend its the year 2005 when single family market values were in a bubble. Let’s say this same house, with the same demographic and household income, and the same long term market rent of $2,600/month existed on that date. However, do to loose lending standards and a supply and demand imbalance the asking price/market value of the house is now $675,000. This asking price is well supported by recent comparable sales in the neighborhood. Buyers, Seller, Appraisers, Bankers are all convinced $675,000 is the fair market value of the house.

8.  On the left side of the timeline press the button labeled “input your value”. In the pop-up window insert the sale price of $675,000 and hit update. Valuexpose recalculates what the ending sale price of $774,831 must be if the present value of $675,000 is to be achieved at a 4% annual yield rate (or discount rate). Once again, at the timeline graphic page’s upper right hand corner, push the “see economic fabric graph (EFG)”.


9.  You can now see the $675,000 current sale price has detached 27.82% from its current $527,999 fundamental/intrinsic value (see bottom right side of the EFG page that displays the 27.82% detachment in value difference). Now press the “show market cycle” button on the upper right hand corner. This resulting graphic overlay indicates the current sale price/market value of $675,000 is not sustainable over a typical seven year holding period. Notice on the right side of the EFG model the household annual income of $139,584 is needed to support a sale price of $675,000. Also notice in both these scenarios the $675,000 current market value and its needed ending sale price of $774,831 and the $527,999 current fundamental/intrinsic value and its ending sale price of $565,423 both have 4% annual yield rates (or discount rates) during the seven year ownership holding period. Consequently, the market is irrationally speculating on the property’s ending sale price of $774,831 that would need an annual household income of $160,249 to support this ending sale price. If Valuexpose was available in 2005, the user of this software would have been aptly warned as the subject’s market value begins or has significantly detached from its fundamental/intrinsic value.



 (See Yields)




10. Valuexpose also indicates buyer opportunities. For the same property example, let’s pretend the bubble has burst and its now the year 2008. The home is now selling for $425,000 Follow the procedure in #9 above to revise the timeline and EFG graphics. The revised EFG graphic indicates the current market value of $425,000 will most likely gravitate toward equilibrium ending sale price of $565,423 (fundamental/intrinsic ending sale price) increasing the owners annual yield from 4% to 7.67% (scroll down to bottom right hand side of EFG graphic to see yield). Once again, notice in both these scenarios the $425,000 current market value and its needed ending sale price of $425,719 and the $527,999 current fundamental/intrinsic value and its ending sale price of $565,423 both have 4% annual yield rates (or discount rates) during the seven year ownership holding period.




(See Yields)




11. Lastly, Valuexpose puts it all together for you when you have completed your analysis. On the timeline page press the button labeled “print report”, or on the EFG page press the button “Single Family Residence/Condo Report”. Both buttons produce the same comprehensive report describing your property’s graphics and results. (See Addemdum with “Single Family Residence/Condo Report)

12. The above demonstration shows you how Valuexpose isolates a property’s current fundamental/intrinsic value from whatever the property’s current market value happens to be as of the same date of value. This new category of valuation analysis prevents you from making critical decisions in a vacuum based on the traditional single-point-in-time appraised market value. Comparing current market value of a property to its fundamental/intrinsic value flushes out hidden risks.

13. There are other important analysis features associated with existing SFR’s and single condos. Getting back to our example, go to the timeline that shows the last current market value we imputed at $425,000. Scrolling down from the timeline graphic shows all the components of value (or forecasts) associated with this property for its current market value to equal its market value of $425,000. Notice in each grouping you can change forecasts within that grouping. You must push the “update” button for that grouping after you have changed any of the forecasts in that grouping. Any changes to other groupings must also hit the “update” button for that grouping before you proceed to the next grouping changes. Once all forecast changes in each grouping have been made and updated, notice that Valuexpose has recalculated your $425,000 market value (or sale price). Simply go to the “input your value” button underneath the right hand side of the timeline graphic and insert again your $425,000 market value. Valuexpose will now recalculates using the $425,000 value and all your changes to the forecasts indicating a new ending sale price plus revised fundamental/intrinsic current value and its ending value.

(See Components of Value)



14. One limitation you might notice when changing forecasts pertaining to average forecast changes in annual market rent is that the percentage changes to your property’s market rent cannot be less than the annual percentages indicated in the fixed and variable expense groupings. We are working to solve this limitation.

15. Another important analysis feature is adding financing (or leverage) to the analysis to find the optimal annual equity yield. Existing Single Family/Condo property types is the only module that preselects the annual property yield (no financing) at the historical rate of 4%. For all other property types and modules, the user is allowed to input this risk rate. Using our former example based on a $425,000 market value, let’s analyze a loan of $400,000 at 3.5% fixed annual interest including $2,500 in closing costs. Underneath the timeline graphic press the button labeled “Remove/Update Financing”. Fill in the pop-up window with the above financing information and hit the “update” button. Timeline values are first updated changing your $385,000 market value input. Simply re-input your $425,000 market value estimate using the “Input Your Value” button. Valuexpose then recalculates and indicated the property’s equity yield displayed to the immediate left of the “Remove/update Financing” button. In this scenario, the equity yield indicates 11.925% (this result might be a little different if you changed some of the original forecasts in the forecast groupings below the timeline). You can continue testing different financing scenario to find the optimal equity yield before a subsequent financing scenario results in a declining equity yield rate. If the financing scenario results in a negative equity yield rate, Valuexpose will show “Caution”.


16. Unlike most valuation software, Valuexpose provides all Discounted Cash Flow (DCF) analysis for all value results. On the left side of the timeline graphic (underneath), you will see buttons labeled “DCF as is” and “DCF as is-financed”. Pushing these buttons displays the customized intricate DCF models so the user can verify the value results.

(See Discounted Cash Flow at the end of the “Single Family Residence/Condo Reportin the addendum)


17. Another interesting analysis feature is being able to access the property’s beginning and ending stabilized income and expense statement used to calculate the property’s annual net operating income. You will find buttons on the timeline graphic labeled “stabilized operating statement”. The button on the left side of the timeline (above timeline) represents the first year of ownership. The button on the right side of the timeline (below timeline) represents the year following the seventh year of ownership and after the property is sold to another buyer.

18. Once you have completed your analysis on your particular property and are satisfied with the results, scroll down underneath the timeline graphic to see the “units of comparison” grouping. This grouping box summarizes all the metrics associated with your property.


19. The above demonstration represents only one real estate classification (residential), one property type (SFR), and one “state of its building existence” (100% completed and stabilized). Valuexpose can analyze 13 different real estate classifications (ex. residential, retail, industry, office, etc.) that include a potential of 320 property types; each in five different states of building existence (100% complete stabilized; 100% complete at non-stabilized; partially complete or needs remodeling; and properties that are to be developed with and without entitlements.

20. Any property types that are to be developed or remodeled also have a patent pending financial feasibility feature indicating whether the developer should proceed with the advancement of the development process. If not, Valuexpose allows the timeline to be extended for a holding period before a development becomes financially feasible. This timeline extension now will show the property’s current “as is” market value on the left side of the timeline and when in the future the property will be ready to start the development.

21. Valuexpose is the first patent pending commercial automated valuation model (AVM) that uses comparable sales with very similar highest and best uses located in markets that are similar to the subject’s market. Valuexpose uses the comparable sale properties components of value forecasts (that make up their sale prices) to value the subject properly if its value is unknown. Now dozens if not hundreds of comparable sales can be automatically used to value your property’s current market value. This gives a more accurate valuation than the traditional comparable sales analysis that is time consuming, expensive and potentially biased.  This new category of valuation analysis further eliminates appraisers logic inconsistencies and incompentency problems due to lack of experience. All valuation results are compared to the property’s fundamental/intrinsic value to flush out hidden risks and keeping you from making important decisions in a vacuum.
  
22. Valuexpose financial reporting option allows the user to initially analyze portfolios of properties on a property-by-property basis. The user can set Valuexpose to update any or all of the properties in the portfolio to update each property’s current market value on a daily, monthly, semi-annual or annual basis (or anything in-between). This analysis feature will also track the relationship of a property’s current market value with its fundamental/intrinsic current value. This relationship tracking will give the user a better strategic management and exit advantage.

23. Now banks that use Vauexpose financial reporting feature can plan their portfolio better on a property-by-property basis. This is the kind of analysis and planning bank examiners are encouraged banks to adopt.


24. If you would like to see another case study on a different property type and/or in a different state of existence (existing building or to be developed/remodeled), you can personally call the founder Ray Dozier, MAI at (760) 413-5011 for a demonstration.