Matrix Blog

Guest Appraiser Columnist:
Jim MacCrate, MAI, CRE, ASA
MacCrate Associates
Appraisal & Valuation Issues Blog

Jim has worn many hats including a Director at PricewaterhouseCoopers in New York City and Chief Appraiser at European American Bank. He is a prolific writer on valuation issues and teaches a number of the real estate appraisal classes through the Appraisal Institute and New York University. I have had the pleasure of taking a number of courses taught by Jim.
…Jonathan Miller

Many so called real estate experts have been predicting the bottom to the real estate market will occur in late 2009 or early 2010. No one can predict with any degree of accuracy the future, much less the bottom of the real estate market in any metropolitan area. It is important for real estate professionals to remember that real estate markets vary by location. Some markets will do well while others are doing poorly. For example, the Detroit real estate market was depressed long before the recession was declared official by the federal government and the beginning of the decline in the New York real estate market. The real estate market in the New York metropolitan area has been driven low interest rates and by the growth of the financial, insurance, and real estate sectors of the economy which began in earnest in first quarter of 2004 as indicated in the following chart:

Total employment is now falling with the FIRE and construction sectors of economy taking a big hit in employment beginning with the collapse of Lehman Brothers. Real estate salespeople, brokers, and appraisers must stop listening to the noise from Washington, D.C., politicians, and others who have mislead us in the past. What we are witnessing, the economists and politicians have witnessed this before during the late 1920’s, the late 1950’s and early 1970’s. In order to properly value real estate, one must cut out all the outside noise and analyze carefully what the local real estate market data is telling you.

On a Macro Basis the Indicators are all Negative

The recent indicators reported by the government suggest that the economy is improving because the rate of unemployment is declining, consumer confidence is improving, the rate of decline in manufacturing is subsiding, etc. All of the above and other statistics still suggests that economy is not improving and real estate values will not begin to rebound until the economy turns over and employment begins to increase with an increasing payroll income and wealth. That is not bound to happen for awhile.

In the New York Metropolitan area, the leading indicators for increasing real property values are all declining, including the following:

• Population is stabilized or falling
• Number of households has stabilized or is declining
• Total employment is declining
• Total payroll/income is declining
• Consumer confidence is negative
• Businesses are still contracting including manufacturing, retail and the financial services sectors of the economy.

The results of the 2010 Census should be interesting nationwide. Listen to what the leading indicators are telling you about the macro market.

Now, on a Micro Basis

Real estate is fixed and immobile. The value of real property is driven by local indicators which impact the demand for real estate in a specific location. All the macro indicators referred to above are also negative in the New York Metropolitan area. In order to determine if the real estate market is rebounding versus stabilizing at a much lower level of activity and prices, the following factors should be analyzed carefully in addition to the factors that generate demand:

• Sale price trends
• Increase/decrease in the number of sales
• Increase/decrease in the number of listings for sale
• Increase/decrease in the number of days on market
• Increase/decrease in sales concessions
• Response to for sale or for lease advertisements
• Increase/decrease in the number of foreclosures
• Increase/decrease in the number of loan defaults.

These trends are extremely important to watch, but the trends will not reverse until consumer confidence is positive and total payroll/income, employment and the number of households is increasing. It must be remembered that real estate prices remained depressed for several years after the recessions of the 1970’s and 1980’s. Why should this time be any different, and, in fact, it is already worse in many markets.

Tags: Europe, James MacCrate, Commerce Dept, Census, Appraisal Institute, Straight from MacCrate, Lehman

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Jim MacCrate, MAI, CRE, ASA has his own firm, MacCrate Associates, but has worn many hats as a Director at PricewaterhouseCoopers in New York City and Chief Appraiser at European American Bank. He is a prolific writer on valuation issues and teaches a number of the real estate appraisal classes through the Appraisal Institute and New York University. I have had the pleasure of taking a number of courses taught by Jim.
…Jonathan Miller

By James R. MacCrate MAI, CRE, ASA

Appraisers are often confronted with an extremely difficult task in New York City and that is to estimate the market value of the excess development rights or air rights associated with an improved parcel of real estate. Point estimates of value are provided by appraisers that may far exceed the potential value contributed by the air rights as of the date of valuation. In fact, in most instances these excess development rights have little or no value as of the date of value, and more importantly, if these rights possess any value there is no exact point estimate of value for a variety of reasons.

In order to have value, in the basic courses of the Appraisal Institute state four factors influence value:

1. Utility
2. Scarcity
   
3. DEMAND
   
4. Effective purchasing power.

In order to have adequate demand to create a market in which to estimate value, there must be a number of buyers that are interested in the excess development rights. But, generally, this is not the case. In most locations in New York City, there must a “receiving site” nearby that meets the exact specifications of the New York City regulations to qualify to acquire and benefit from receiving the additional development rights. A market is required in order to estimate market value.

A market is defined by the Dictionary of Real Estate Appraisal as:

1. A set of arrangements in which many buyers and sellers are brought together through the price mechanism.
   
2. A gathering of people for the buying and selling of things; by extension, the people gathered for this purpose.

The restrictions placed on the transfer of air rights or excess development rights are limited by the New York City regulations. In most instances, the demand for excess developments rights is limited, if they exist at all. Therefore, there is no market as defined by the Appraisal Institute. So, I pose a question as to how can real estate appraisers give added value to a parcel of real estate when there is no market as defined above for air rights or excess developments rights?

Appraisers often, incorrectly, add additional value when in fact there is no market or demand. What’s worse is that financial institutions lend on the higher value that includes a speculative assumption that a market exists for these rights when, in fact, there is no market. Improperly trained review appraisers and loan underwriters fail to catch this situation. (Oh well, we are bailing out the financial institutions).

In the Appraisal Journal, October 1982, an article appeared “Valuing Real Estate under Conditions of Bilateral Monopoly” which addresses many of these issues. In most instances, only one potential buyer exists and possibly several potential sellers, if any and this is known as “monopsony.” This is a classic bilateral-monopoly problem where both the added value to the receiving parcel (buyer) and the diminution in value to the seller can only be estimated after negotiation between the two parties involved. The appraiser does not know the value of the excess development rights to the seller as of the date of the appraisal unless those rights have been sold. And, just because the rights may be sold and under contract does not mean that the price paid represents market value.

Assuming that the owners of the excess development rights and the “receiving site” are well informed or well advised, and acting in what they consider their own best interests, individual specific values for the excess development rights or air rights can be determined that establishes the negotiating range between the parties. The final transaction price is determined by the negotiating skills of the two parties to protect their own interests.

Tags: Soapbox Blog, James MacCrate, Appraisal Process, Straight from MacCrate

Comments Off on [Straight From MacCrate] Air Rights in New York City Where’s the Market Hence Where’s the Value?

Jim MacCrate, MAI, CRE, ASA has his own firm, MacCrate Associates, but has worn many hats as a Director at PricewaterhouseCoopers in New York City and Chief Appraiser at European American Bank. He is a prolific writer on valuation issues and teaches a number of the real estate appraisal classes through the Appraisal Institute and New York University. I have had the pleasure of taking a number of courses taught by Jim. His wife Judy is an SRA and is an accomplished appraiser in her own right, having managed an appraisal panel for a large lending institution throughout its various mergers for a number of years. I can only imagine the riveting conversations at dinnertime.

…Jonathan Miller

By James R. MacCrate MAI, CRE, ASA

I have had the opportunity to review many real estate appraisal reports over the last two years and I am amazed by the number of real estate appraisers who only use

to develop overall capitalization rates. Commonly known as the Ellwood formula. No wonder why folks question real estate appraisals on commercial properties. This formula does not reflect the actions of informed real estate investors. In fact, in 1971, Max Ramsland, MAI pointed this out succinctly in his article “Ellwood: A Practitioner’s Observations” in The Appraisal Journal. In English, this formula basically states that an indication of the overall capitalization rate can be developed by taking the following steps:

The Ellwood formula was designed as an analytical tool for real estate appraisers, investors and other real estate professionals. Its misuse was clearly evident during the real estate collapse of the 1970’s and 1980’s. The model above is for a level income stream over a specific number of years. Who buys real estate expecting the income to be level over the projection period? If income and value are expected to change over time, the Ellwood J or K factor must be applied and incorporated into the formula. It appears that it is being misused again by real estate appraisers. Mr. Ramsland points out several weaknesses that are worth revisiting at this juncture.

First, it is extremely difficult to verify the equity yield rate required to attract investors to real estate investments. Many real estate investors will not disclose their “hurdle rates” to invest in real estate. Abstraction of the required information to properly apply this methodology is difficult. During the last several years many transactions that occurred were the result of a 1031 or tax-deferred exchange which created aberrations in the observed overall rates, sometimes below 4.00%. These transactions were driven by after tax returns and appraisers generally do not have access to the information required to develop a proper analysis. Many of the transactions were not economically justifiable and this is becoming evident now. If this information is abstracted from historical transactions it can be very misleading without proper consideration of the market conditions as of the date of sale. Mr. Ramsland points out that investors have various reasons for making an investment decision: some of which are well thought out and others who dream about the future and hope, but are incorrect.

Appraisers often assume that investors will hold the property for ten years and that the property will appreciate in value. The market indicates that values do not always go up and, in fact, can decline for long periods of time and/or stay stabilized. Finally, what investors use this analysis to make an investment decision? I have been in this business for more than 25 years and the last time investors used this model the real estate market collapsed.

Mr. Ramsland further points out that “the allowance for depreciation can have a measured affect on the final value estimate if not realistically applied. A more serious problem could exist, however, if the appraiser projects an equity-yield and depreciation factor inconsistent with safe investment practices.”

Terry Grissom, PhD, at the University of Ulster, Ireland points out that the issue of stable income and the assumptions behind an accumulated sinking fund growth factor is an accrual valuation measure that is inconsistent with discounted cash flow analysis and the cyclical nature of real estate investments. Valuation needs to explicitly cope with changes over time to return to equilibrium or growth assumptions during down phase. Don’t misunderstand me, the Ellwood formula is an excellent tool in the arsenal that appraisers have to utilize to develop overall rates if applied correctly; but with computers available today, appraisers should apply the methods employed by investors who acquire real estate. In addition, more than one method should be used to support a capitalization rate. The appraiser can consider the following methods to develop an appropriate overall rate:

• Interview market participants
• Review published surveys
• Abstraction from comparable sales
• Abstraction from multipliers developed from comparable sales
• Developed by the band of investment method
• Estimated by the debt service coverage ratio method
• Abstraction from expected property yield rates.

All techniques to develop a capitalization rate should produce similar results if properly constructed with the correct assumptions.

Note – Thanks to Max Ramsland, MAI, Duluth Minnesota and Terry Grissom, PhD, University of Ulster.

Tags: Soapbox Blog, James MacCrate, Appraisal Process, Straight from MacCrate

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Jim MacCrate, MAI, CRE, ASA has his own firm, MacCrate Associates, but has worn many hats as a Director at PricewaterhouseCoopers in New York City and Chief Appraiser at European American Bank. He is a prolific writer on valuation issues and teaches a number of the real estate appraisal classes through the Appraisal Institute and New York University. I have had the pleasure of taking a number of courses taught by Jim. His wife Judy is an SRA and is an accomplished appraiser in her own right, having managed an appraisal panel for a large lending institution throughout its various mergers for a number of years. I can only imagine the riveting conversations at dinnertime.

…Jonathan Miller

Are Land Investments Frozen or Liquid?

Do the FEDS Know What Land is Worth Now?

By James R. MacCrate MAI, CRE, ASA

Turbulent times are affecting real estate values as the value of homes, apartment buildings, retail facilities, and office buildings fall in most markets. I wonder if the auditors, lenders and investors are going to value development projects correctly.

Land gets hit the hardest, but most lenders and developers do not see it that way. In the real estate market, developers use the three factors of production, land, labor, and capital in order to make a profit. Developers provide the fourth factor in production, coordination.

In the current environment, the cost of raw materials has escalated, cost of capital is increasing, the value of the finished product, i.e., an office building, condominium units, single family homes, is falling. In addition, risk takers or developers want a higher return on their equity capital and coordination. Something must give, and that is land value. In classic economic theory, land has the last claim to the residual income.

Developers have reported that when analyzing land, they determine the appropriate product that the site can support, given the location, development regulations, and market conditions, and then estimate the probable price that will be paid for the final product. Deductions are then made for construction costs, profit and overhead, site improvement costs and, if necessary, cost of approval, to arrive at the price per lot of the site with road and utilities to the property line. Any additional offsite costs to bring the property to that state (extending roads or utilities, or making township contributions) must then be deducted as well. The resulting figure is the residual land value.

Historical Trends

Because real estate traditionally competes within capital markets for funds, we compared the historical expected returns from investments in land found by surveys completed by MacCrate Associates LLC, Price Waterhouse LLP, and the Korpacz Real Estate Investor Survey to alternative investments, including: residential mortgages, Baa Rated Bonds, and the ten-year treasury.

The chart clearly indicates that returns on land investments began to fall before 9-11 and spiked back up after 9-11 and, then, trended downward as demand for real estate increased because of very favorable financing. But, the returns prior to 1997 were relatively constant at just over 20%. It is reasonable to assume that investors will, again, require average returns in excess of 20% for speculative transactions. In fact, back in the early 1990’s many investors wanted a 25% to 40% return or more to invest in vacant land. The spreads between the expected land investment return and the ten-year treasury narrowed during the last few years but will probably widen as land as land investments become frozen or illiquid at any price.

Back in the 1990’s

The following chart, from Price Waterhouse LLP, summarizes the expected return by residential developers from 1990 through 1998. Average expected return declined from 27% in 1990 to 20% in 1998.

By 2002, the expected returns were back above 20% briefly, but declined to lower levels that were expected in the mid-1980s when the market was very strong. Currently the Korpacz Real Estate Investor Survey indicates an average of 17.5%. That won’t last long.

So We Can Only Hope That.

The folks in Washington D.C. who are proposing to buy all these mortgages and closing lending institutions that may be in financial trouble must price the assets correctly to reflect the true risk and return that we deserve as taxpayers and investors. Proper valuations require an appraisal which would include a market analysis to ensure that the risks are captured in the discounting process to estimate value and unfreeze the land investments that have been made.

A simple hypothetical example can see the impact that the current crisis is having on the value of land for apartment projects:

During periods of weakness, vacancies increase. In addition, the cost of utilities has been rising. But, this calculation has not taken into consideration the following:

• Time value of money
• Increase in interest carry
• Time to lease up
• Increase in marketing costs
• Real estate taxes, theoretically, could be increasing while the value is declining
• Possible increase in construction costs, besides interest carry
• Increased entrepreneurial incentive.

What if the returns regress back to the 1990 returns on vacant land? What if the highest and best use was as condominium project before? What happened to the land value when the condominium unit prices are cut in half? Next time!

Rick Wincott, MAI, CRE and Jim MacCrate, MAI, CRE with the assistance of Scott Koenig, wrote an article on Land Valuation and Purchase Price Decisions. You can obtain a copy from Rick Wincott or Jim MacCrate.

Tags: Soapbox Blog, James MacCrate, Straight from MacCrate

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Jim MacCrate, MAI, CRE, ASA has his own firm, MacCrate Associates, but has worn many hats as a Director at PricewaterhouseCoopers in New York City and Chief Appraiser at European American Bank. He is a prolific writer on valuation issues and teaches a number of the real estate appraisal classes through the Appraisal Institute and New York University. I have had the pleasure of taking a number of courses taught by Jim. His wife Judy is an SRA and is an accomplished appraiser in her own right, having managed an appraisal panel for a large lending institution throughout its various mergers for a number of years. I can only imagine the riveting conversations at dinnertime.

UPDATE: Mark your calendar, Jim has been invited by the Wisconsin Chapter of the Appraisal Institute to address distressed commercial real estate properties for professionals including real estate brokers, owners, and appraisers. The Appraisal Institute is inviting the FDIC to attend this critical and timely seminar on August 27th, 2008 in Milwaukee, Wisconsin.

Here’s how to sign up for the seminar.

…Jonathan Miller

Real estate appraisers have to be wondering what property values are doing in Manhattan and elsewhere. Clearly, the real estate market is being hit by numerous factors that are affecting property values. The following chart indicates how Manhattan apartment values have changed in comparison to changes in the nationwide apartment value index, CPI index and applying capitalization rates to the projected changes in income to develop indexes based on the average and median long term (20 plus years) capitalization rates. From 1998 through 2003, apartment value trends followed the CPI very closely.

The nationwide apartment value index followed a similar pattern to New York’s until 2003. If the long term average or median capitalization rate is applied to the projected net operating income, apartment values in Manhattan would not have kept pace with inflation in New York.

Impact of Financing

Other factors drove the increase in apartment values. The following chart indicates the path the apartment capitalization rates took for the last eight years or so. Optimism, lower interest rates, huge capital inflows (beginning in the latter part of 2003) and tax free exchanges drove apartment prices into a bubble that is waiting to collapse.

If it is true that over the long term real estate values keep pace with inflation and returns regress toward the mean, Manhattan apartment values are in for a rough ride. If rates of return do regress toward the mean as interest rates increase, a large drop in value is indicated or values will remain stable waiting for the CPI to catch up. During the 1970’s and early 1990’s, apartment values declined and, then, stabilized for several years.

But Wait.

Not only are interest rates and debt coverage ratios increasing, all operating costs are increasing quite rapidly in the New York area. The NYC RGB forecasted the following expected increases in operating expenses from April 2007 through April 2008 for all apartment projects as follows:

During the first six months of 2008, fuel costs have already reportedly increased 20% annually. Real estate taxes will have to be increased more than expected to cover the shortfall in city revenues from other sources. All other costs will probably follow the inflationary spiral that has begun. Increases in rental income generally lag expense increases.

What will hurt apartment values will be increasing capitalization rates, operating costs and switching from interest only loans to amortizing loans. It would not be surprising to see an increase in delinquencies within the next six months or so. Lenders will be forced to modify loans or foreclose.

In addition, the New York City Comptroller’s Office issued a report stating “the real estate sector accounted for nearly $200 billion of the New York metropolitan area’s gross product in 2005, showing a location quotient of 1.3, or 30 percent higher than the national average.” That sector is contracting along with the financial services sector which accounts for 13.6 percent of the regional economy. Job growth is slowing and unemployment is rising.

So, The Question Is Not If But When?

The following chart provides a summary of the estimated apartment capitalization rates over time.

With capitalization rates falling below 6.00% during the mid-2000, it is only a matter of time for the rates to regress back to the mean and let the air out of the balloon. The events unfolding were predictable and the general historical patterns are similar. Financial regulation and sound underwriting policies disappeared during this time period of “irrational exuberance.”

Tags: Soapbox Blog, James MacCrate, Straight from MacCrate

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Jim MacCrate, MAI, CRE, ASA has his own firm, MacCrate Associates, but has worn many hats as a Director at PricewaterhouseCoopers in New York City and Chief Appraiser at European American Bank. He is a prolific writer on valuation issues and teaches a number of the real estate appraisal classes through the Appraisal Institute and New York University. I have had the pleasure of taking a number of courses taught by Jim. His wife Judy is an SRA and is an accomplished appraiser in her own right, having managed an appraisal panel for a large lending institution throughout its various mergers for a number of years. I can only imagine the riveting conversations at dinnertime.

Jim shares his thoughts on how taxing the real property tax process is – like a maze of pipes.
…Jonathan Miller

I have a great deal of respect for civil servants and the professionals who work in the real property tax assessment offices throughout our country. Many hold appraisal licenses in their respective states and are members of the Appraisal Institute, The International Association of Assessing Officers, American Society of Appraisers, and other professional organizations. Theirs is an extremely difficult job; nobody really likes them because the general public perceives them as tax collectors. In actuality, politicians determine the budgets and set the tax rates applied to the assessed valuation that determines your real property tax liability. In addition, politicians tend to limit the resources for the real property assessors to do an adequate job. Further they fail to enforce standards such as mandatory licensing for all personnel in the real property tax departments, hearing officers and judges who hear the grievances, and the property owners’ representatives who prepare the tax appeal cases.

Real property taxation is no longer a fair and equitable method to pay for the cost of government and social services. At one time, real property represented the majority of wealth and produced most of the income from farming and other operations. Wikipedia states that the conventional property tax has some advantages—simplicity, stability, and open record keeping—but also many disadvantages.

The first disadvantage is market value assessment procedures. Market value can change dramatically with the fluctuating real estate market conditions as we are just witnessing. The second disadvantage is selected assessment and visibility because rent and leaseholders are not directly taxed. Most often the current assessed value is unrelated to any implied level of government service. Further inequities include that property taxes do not adequately provide for education and other social improvements in impoverished areas. Because real property valuation is more of an art than a science, the real property tax system has become just as corrupted as mortgage brokerage operations on Wall Street. Likewise our politicians ignore the fixes that are required, just as they failed to act to prevent our current mortgage banking meltdown.

Wealth today is no longer concentrated in real estate because on average it has been leveraged to 80% or more. In addition, the mortgage financing opportunities of the last five years created fictitious wealth and many individuals who were mislead, today are struggling or defaulting on their mortgage payments, so don’t have a prayer of meeting their real property tax liabilities. Financing influences the price paid for real estate; certainly the irresponsible actions of Wall Street and the bankers during the mid-2000s have resulted in inflated real property values from 15%-20% or more across the board in most communities. Any reassessment based on sales inflated by favorable financing is neither justified, nor equitable. Instead of real estate, wealth is now concentrated in stocks, bonds and other investment vehicles.

In addition, many lawyers and appraisers who present tax appeals are not licensed and thus not required to subscribe to a code of ethics similar to those of professional appraisal organizations. Similar to appraisals prepared by mortgage brokers, their improper valuations are biased, so their status as advocates is questionable. Their compensation is often contingent on the tax savings, regardless of whether the tax ruling is fair and equitable to the remaining residents in the community who must pick up the shortfall.

As a member of the Appraisal Institute, my compensation cannot be contingent upon the reporting of a predetermined value or direction in value that favors the client’s cause, the amount of the value estimate, the attainment of a stipulated result, or the occurrence of a subsequent event. In addition, my analyses, opinions, and conclusions are developed, and my reports have been prepared according to the Code of Professional Ethics and the Standards of Professional Practice of the Appraisal Institute and in conformity with the Uniform Standards of Professional Appraisal Practice. Most importantly, if someone in the tax assessment department feels that I have violated that code of ethics, he/she can send my reports to the Appraisal Institute for peer review.

Now is the time for our politicians to focus on alternatives to real property taxation to be fair and equitable. At the very least, licensing should be mandatory for all practitioners involved in the real property tax assessment process, which includes attorneys, hearing officers, judges and anyone involved in assessment-related activities.

The author was on the Board of Assessors and the Assessment Review Commission in Nassau County. Thanks also for editorial assistance from Nancy Reiss, The Write Stuff and Max Ramsland, MAI.

Tags: Soapbox Blog, James MacCrate, Straight from MacCrate

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Jim MacCrate, MAI, CRE, ASA has his own firm, MacCrate Associates, but has worn many hats as a Director at PricewaterhouseCoopers in New York City and Chief Appraiser at European American Bank. He is a prolific writer on valuation issues and teaches a number of the real estate appraisal classes through the Appraisal Institute and New York University. I have had the pleasure of taking a number of courses taught by Jim. His wife Judy is an SRA and is an accomplished appraiser in her own right, having managed an appraisal panel for a large lending institution throughout its various mergers for a number of years. I can only imagine the riveting conversations at dinnertime.

In this post, Jim and his accomplished colleague George McCarthy get gloomy.
…Jonathan Miller

The chart indicates the long term trends in Nassau County’s housing market based on proprietary data maintained by George McCarthy, MAI at Real Property Advisors and James R. MacCrate at MacCrate Associates, which indicates the long upward trend in prices came to an end in 2005-2006 and the long downward trend has just started.

Trends in Westchester and Suffolk Counties are quite similar with Manhattan to follow Staten Island, Brooklyn and Queens downward. This will create a major dilemma for politicians who have relied on the baby boomers, new construction, increasing home values and mortgage applications to provide the cushion to maintain real property tax rates. New construction is slowing, mortgage applications are down and real property values will continue to decline which will impact real property transfer taxes, recording fees, mortgage taxes, and all associated municipal income generated from the “bubble” created by the Federal Reserve and the lax government regulation for the last five or six years.

The preceding chart does not clearly show the extent of the downturn in the early 1990’s. It is interesting to note that home prices declined between 10% and 25% during the last downturn in the early 1990’s and more than 15% during the mid-1970’s. The current downturn has just started and will escalate as massive layoffs at Citigroup & Merrill and other financial institutions continues into the future. Industry-wide reduction in revenue and bonuses and repercussions in related industries will affect the demand for housing and commercial real estate.

To compound the problem, sales tax revenue will fall as consumers feel the pain and lack the resources to live beyond their means. The baby boomers retiring will begin to flood the market with their homes and move out of high tax states and municipalities, such as New York, Nassau and Suffolk Counties to lower tax areas in the country that favor retirees. It’s usually the oldest & youngest who get pushed out when companies reduce staff, via early retirement and layoffs. There are insufficient high-income wage earners coming into the New York Metropolitan area to acquire the homes the baby boomers want to leave behind. The statistics tend to indicate that it will take many years for the housing market to recover from the scandalous activities of the financial industries, from the local bankers to Wall Street executives who knew quite will what they were doing and are getting off scot free with bonuses when they get fired or their firms collapse, while the little guy who has worked so hard sees their equity evaporate. Where were our political leaders in the State and Washington, D.C? These institutions are not done yet! Bond insurance anyone?

It would also be interesting to see what the Feds, state, city and surrounding counties have been spending their increased revenues on over the last seven years. Have they been necessary services, or beautification, gentrification and pilot projects? Do these projects support long term growth or short term gains for the local politicians? Based on what I see, we have had fraud and waste at all levels because no one was watching the “piggy bank”.

The leaders in our democracy better wake up, because the long term picture for real estate is not rosy to say the least! Only, Mayor Bloomberg has sounded the warning. Who is really going to hurt? Are politicians really going to raise property taxes or reduce police forces to maintain revenue on non-necessary services? In an election year? O and by the way, the recent lowering of interest rates will not help the housing industry in the short run.

Regulations existed to protect the innocent and punish the individuals that were responsible for this mess. But, they all but disappeared beginning in the 1970’s and 1980’s. We will all pay the price, I’m sorry to say. This will not end next year or the next…..we remember the five good years, forget the five bad years; and, now we will have at least four or five bad years for other reasons.

Tags: Soapbox Blog, James MacCrate, Straight from MacCrate

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Jim MacCrate, MAI, CRE, ASA has his own firm, MacCrate Associates, but has worn many hats as a Director at PricewaterhouseCoopers in New York City and Chief Appraiser at European American Bank. He is a prolific writer on valuation issues and teaches a number of the real estate appraisal classes through the Appraisal Institute and New York University. I have had the pleasure of taking a number of courses taught by Jim. His wife Judy is an SRA and is an accomplished appraiser in her own right, having managed an appraisal panel for a large lending institution throughout its various mergers for a number of years. I can only imagine the riveting conversations at dinnertime.

Now when the lending community really needs to know what the values are…
…Jonathan Miller

No one orders a real estate market analysis anymore or they are poorly done!

Not the banks, not Wall Street and clearly not home builders. Yet home builders today are feeling the pain that results from a poor or missing market analyses. Wall Street analysts, rating agencies, and their advisors, including the accounting firms that report on the financial conditions at similar companies, do not seem to understand the residential real estate industry. Either that or they have been looking at the wrong data for two years or so.

The following chart summarizes how publically traded home builder stocks have fared this year.

Ouch!

Wall Street analysts who report on these companies and recommended their shares, as well as company management and their advisors, would have to give back a large portion their pay, bonuses, benefits, stock options, etc. to their shareholders to offset the losses that were incurred as a result of overly optimistic forecasts. In fact, New York State Comptroller, Thomas DiNapoli, estimated a 10% drop in Wall Street bonuses this year. With average year to date home-building stock prices down well below 50%, management equity (not to mention job security) would be similarly off. Yet this doesn’t come close to the losses incurred in the housing market. Regrettably, many of these losses could have been avoided by obtaining a properly prepared real estate market analysis.

The overall weakness in the residential real estate market was well known going into 2006: demand was falling and an inventory glut was beginning to take place. There is only limited demand at any one time; nevertheless, supply kept coming and the residential property cycle turned down. Current market indicators show that the housing recession will worsen in coming months, which may further impact the underlying value of the assets owned by many of these companies.

As demand peaked, poorly planned additions to supply continued. This was caused by many factors, including incorrect market analysis of potential supply and effective demand. Many inexperienced investors, analysts, appraisers and accountants, seeing the soaring profits in residential development, recommended entering the market in 2004-2006. They purchased vacant land outright, and began construction, thinking that effective demand would remain forever. Prices for land were increasing so fast that developers moved to lock up property without completing the proper market studies. Lenders were all too accommodating for the fee income. Similar to the stock market, investors became speculators in residential development, but lost due to their fear of poor timing and shades of greed.

Compounding the sudden leaps in price was the much slower permit process. Obtaining the necessary permits to develop residential real estate often takes one or two years, and as long as five or six years in certain markets. If one entered into a contract to purchase vacant land in late 2003, the market was in a down-turn by the time all entitlements were obtained. Yet, bankers provided the money and developers continued to move forward, being optimistic opportunists. The result? A repeat of the 1970’s and 1990’s debacles in residential real estate!

It appears that no one, neither Wall Street, company management, their accountants, advisors nor the lenders learned anything from the earlier cycles in real estate development. (Everyone over fifty was fired or let go for youth, many who are still learning. But that’s another article.)

A proper real estate market analysis would have predicted the change in market conditions based on analyzing the following factors correctly:

This list is only a partial catalog of factors that should have been considered by all of the players in the real estate market. Until real estate market analysis is bought back by company management, accountants, Wall Street analysts and lenders, we should expect ratings to be reduced and dividends to be cut and more losses and loan write-offs to occur in the real estate and banking industry.

Special thanks to Noreen Whysel who provided some input and assistance.

Tags: Soapbox Blog, James MacCrate, Straight from MacCrate

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Jim MacCrate, a regular contributor to Soapbox through his “Straight from MacCrate” column recently wrote a research paper with Noreen Whysel called:

Appraisal Reviews and Their Importance

which was recently listed on Social Science Research Network’s Top Ten download list for Litigation, Procedure & Dispute Resolution Journals. This article may be of interest to attorneys and others who read and review real estate appraisal reports. To view the top ten list for the journal click on its name Litigation, Procedure & Dispute Resolution Journals Top Ten and to view all the papers in the journals click on these links link(s) Litigation, Procedure & Dispute Resolution Journals All Papers.

Appraisal review is a big issue. We regularly perform reviews of other appraiser’s work in litigation and they review ours.

Tags: Soapbox Blog, James MacCrate, Appraisal Process, Straight from MacCrate

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Jim MacCrate, MAI, CRE, ASA, has worn many hats in his career. He taught a number of the appraisal classes I have taken through the Appraisal Institute and I think he is one of the few people who actually understands the “J-Factor.” His wife Judy is an SRA and is an accomplished appraiser in her own right, having managed an appraisal panel for a large lending institution throughout its various mergers for a number of years. I can only imagine the riveting conversations at dinnertime.

This week, Jim tries to tackle accounting standards and their contributory residual confusion.
…Jonathan Miller

International Financial Reporting Standards (IFRS) are standards and interpretations adopted by the International Accounting Standards Board (IASB). The objective of these Standards that are applicable to leases, property, plant and equipment, investment properties, and intangible assets are to prescribe the proper accounting for reporting purposes and the related disclosure statements in order for users of the financial statements to obtain information about an entity’s investments. The primary purpose in accounting for real property and intangible assets is to identify the assets and their estimated values and the depreciation charges and any impairment that result in losses. When a foreign investor acquires partial interests in real property, the valuation issues can be extremely complex which, if not calculated correctly, can result in inaccurate results that can impact the income and financial statements of the reporting entity.

For example, a foreign investor acquires a retail condominium unit or a penthouse office unit in New York City. How does one estimate the contributory value of the site for purchase price allocation purposes if the retail unit is on the first floor or if an office unit is on the top floor overlooking the Hudson River? What is the contributory value of the common elements? For tax purposes, all investors want a lower site value and a higher value associated with the improvements in order to maximize depreciation which will lower the tax bill due to Uncle Sam and, possibly foreign taxing authorities.

Recent transaction prices for development sites in prime locations in New York City ranged from $400 to $875 per square foot of floor area permitted as of right for high rise mixed-use projects. Clearly, the contributory value of the site for the first floor retail use on Madison Avenue would be substantially higher than the average price paid per square foot of floor area permitted since the rents obtained for first floor space can be sky high in comparison to the rent per square foot collected for the upper floors for office or residential use. The following chart summarizes the average asking retail rent for selected locations in Manhattan in early 2007 in comparison to 2006 as reported by The Real Estate Board of New York:

The asking office and residential rents in the same locations for the upper floor space are well below the rents that can be achieved for the first floor space. The average asking rent for office space in Midtown was approximately $79.00 per square foot in February 2007. In addition, many retail tenants are paying all expenses while tenants on the upper floors may only be paying an increase in operating expenses. The construction costs associated with retail space are also generally lower. As a result, the residual income to the retail site component after allowing for a proper return on the invested capital in the retail improvement component would be substantially higher than the residual income to the office or residential site component after allowing for a proper return on the office or residential improvement component.

The Appraisal Institute indicates that there are six methods that are available to estimate the contributory value of the site to the total value. These include the following:

• Sales Comparison Approach
  
• Extraction
  
• Allocation
  
• Land Residual Technique
  
• Ground Rent Capitalization
  
• Subdivision or Development Method
  

The methods to estimate site value are more fully described in the article Land Valuation and Purchase Price Decision but it is clear that in cities such as New York, Chicago, Washington, D.C. and San Francisco it is extremely difficult to apply any of these approaches to allocate the purchase price between the various components in a condominium project. The land residual technique, if correctly applied, may provide a reasonable indication of the contributory value of the site to the overall value on an individual condominium unit. Alternatively, the estimated contributory value of the site might be estimated by the relative undivided interest in the condominium based on relative sale prices of the various units. If this is the case, then, the value contributed by the site to the retail unit is clearly different than the average price paid per square foot of floor area permitted as of right.

The United States standards are developed by the Financial Accounting Standards Board. The objective is similar and numerous standards have been issued to provide guidance to practioners which is clearly a duplication of efforts to protect investors and the general public. These pronouncements include the following: FAS 141, FAS 142, FAS 144, and FAS 157 with more to follow I’m sure to confuse the general public and the investors even more. Be that as it may, the appraisers that are involved in preparing and reviewing real property valuations, including the I.R.S. and taxing authorities, for purchase price allocation and other purposes should be careful. Because of the intricacies involved, the calculations may affect all taxpayers, investors and the general public.

Special thanks to Richard D. Wincott, MAI, CRE, PricewaterhouseCoopers LLP., William Kinn, MAI, CRE, Kinn Real Estate Counselors LLC., and Joseph Petrocine, MAI, Regional Appraisal Associates, for their input.

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Jim MacCrate, MAI, CRE, ASA, has worn many hats in his career. He taught a number of the appraisal classes I have taken through the Appraisal Institute and I think he is one of the few people who actually understands the “J-Factor.” His wife Judy is an SRA and is an accomplished appraiser in her own right, having managed an appraisal panel for a large lending institution throughout its various mergers for a number of years. I can only imagine the riveting conversations at dinnertime.

As the rest of his colleagues (self included) lounge by the pool at the close of summer, Jim is hard at work thinking about the accuracy and impact of property taxes on real estate investments. His dedication is almost saint-like.
…Jonathan Miller

Just a reminder to investors and appraisers—real property taxes have a major impact on real estate valuation and investment returns and need your accurate analysis. Don’t just call the local assessor for the current real estate taxes and plug the information into a model to calculate the real property’s net operating income. Real property taxes are always volatile because of increasing government expenditures, reassessment upon sale, phased reassessments, elimination of exemptions for improvements, and tax abatement programs.

Why is such detailed analysis important? Most tenants for residential and commercial properties can only afford a specific percent of their gross income for occupancy costs (real estate taxes, rent, insurance and utilities). Once the occupancy costs exceed this percentage and the tenant risks defaulting on the lease, the real estate value can be affected. Your task is to clearly spell out any hypothetical or extraordinary assumptions about the real estate tax estimates.

What can you do to avoid being blind-sided? Start by getting the correct information. Remember real estate brokers do not always do their research. Be cautious if you analyze investments in different geographical locations. In fact, the Uniform Standards of Professional Appraisal Practice (USPAP) states that “Prior to accepting an assignment or entering into an agreement to perform any assignment, an appraiser must properly identify the problem to be addressed and have the knowledge and experience to complete the assignment competently…….” and “Competency applies to factors such as, but not limited to, an appraiser’s familiarity with”:

• The specific type of property
  
• The real estate market
  
• The geographic area
  
• The correct analytical methods
  

If you find yourself in an unfamiliar location, such as New York or Miami , investigate not only the supply and demand factors affecting the local real estate market, but also obtain sufficient information to project the real estate taxes over the investment holding period. You may need to affiliate with a qualified local real estate appraiser to develop the stabilized income and expense forecast with the correct real estate tax estimate for your direct capitalization and projected discounted cash flow analysis. Consider the following factors that can impact accurate real estate tax calculations:

• The equalization rate may not represent the effective equalization rate or the stipulated rate in the municipality.
  
• The tax rate may only be declining in the short term if new construction does not continue into the future.
  
• The tax rate may increase dramatically with new government expenditures or unforeseen circumstances.
  
• Reported exemptions may be inaccurate.
  
• Although the property is reassessed on sale, expect a two- or three-year lag until the tax authority incorporates this reassessment.
  
• The real property assessments for all the tax comparables may have calculation inaccuracies from programming or human errors.
  
• Rental rates may have spiked and the taxing authority has yet to capture this increase in real property values and the assessed value.
  
• Property-specific information may be inaccurate and impacts taxes until corrected.
  
• Tax assessment changes are phased in over a number of years, while the taxable value increases every year.
  
• Tax abatements that generally are phased out over time must be factored into the analysis.
  

As a final note, do not forget transfer taxes and mortgages taxes that can also affect your returns on real estate investments.

Note: a special thanks to Nancy Reiss of The Write Stuff.

Tags: Soapbox Blog, James MacCrate, local market knowledge, USPAP, Straight from MacCrate

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Jim MacCrate, MAI, CRE, ASA, has worn many hats in his career. He taught a number of the appraisal classes I have taken through the Appraisal Institute and I think he is one of the few people who actually understands the “J-Factor.” His wife Judy is an SRA and is an accomplished appraiser in her own right, having managed an appraisal panel for a large lending institution throughout its various mergers for a number of years. I can only imagine the riveting conversations at dinnertime.

This week Jim gets a bit DCF’ed about how Wall Street does not fully explain how it values real estate. He believes its a looming problem.
…Jonathan Miller

The Global Equity Research Department of Lehman Brothers recently published the REIT NAV Handbook which summarizes the valuation methodology employed to estimate NAV which is defined as “an estimate of the private market value of a company’s assets.”

Anyone who understands real estate clearly sees the risks inherent in the valuation process that Lehman Brothers has used to estimate the private value of the companies assets. The process does not appear to conform to the Standards of the Appraisal Institute or the American Society of Appraisers. If they use the same procedures to value investments that they have made in real estate companies or real estate investment trusts, they may very well have to take some hits too when they have to “mark to market.”

Consider Lehman’s methodology, outlined as of June 2007:

“We first calculate a forward 12-month cash net operating income (NOI) based on annualized 1Q07 GAAP net operating income (real estate NOI plus joint venture NOI, adjusted for partial contributions, less lease termination fees where included in rental revenue), multiplied by an appropriate growth rate for the next 12 months, minus annualized straight-line rents. In cases in which joint venture NOI was not available, we used the equity in unconsolidated subsidiaries reported on the company’s income statement. (Please note that, for malls and outlets, a rolling four quarters of NOI is used to account for the quarterly fluctuations in revenue driven by percentage rents.)

The resultant cash NOI is then capitalized at an appropriate cap rate (adjusted for the quality of a company’s assets) to determine the implied value of owned properties. We next add capitalized management fee/service income (using between a 12% and 20% cap rate, in most cases), cash and cash equivalents, construction in progress at 110% of cost, any land being held for development, other assets, and, in some cases, the value of tax-exempt debt in order to arrive at the gross market value of a company’s assets.

To determine the net market value of assets, we then subtract all of the company’s liabilities and obligations, including preferred stock at liquidation value and the REIT’s share of joint venture debt.

Our NAV estimates make no adjustment for any mark-to-market on company debt.”

The blog format does not lend itself to an all-inclusive discussion of all the issues and standards. One must remember, however, that Wall Street is not subject to the Uniform Standards of Professional Appraisal Practice (USPAP). Perhaps they should be to protect the general public. For starters, are the individuals who prepared this analysis competent? According to USPAP, to be competent, the analyst must be familiar with the type of property, the subject market, the geographic area and the appropriate analytical methods for determining value for that type of property. Their qualifications have not been provided.

The second problem deals with scope of work which, according to USPAP, should be clearly delineated so that investors can ascertain the risks associated with this type of analysis. This includes but is not limited too:

* “the extent to which the properties are identified;
* the extent to which tangible properties are inspected;
* the type and extent of data researched; and
* the type and extent of analyses applied to arrive at opinions or conclusions.”

I presume that the information was provided by the individual companies which would tend to be biased, as history and common sense have indicated. The credibility of the results is always measured in the context of the intended use. I will let the individual judge whether the scope of work is adequate to make an investment decision in any of the REITs discussed. In fact, the term “private market value” is not even defined.

While there are many criticisms that will be left unresolved, I would like focus on the second paragraph and specifically the following statement:

“We next add capitalized management fee/service income (using between a 12% and 20% cap rate, in most cases), cash and cash equivalents, construction in progress at 110% of cost, any land being held for development, other assets, and, in some cases, the value of tax-exempt debt in order to arrive at the gross market value of a company’s assets.”

No justification or support has been provided for the 12% to 20% capitalization rates selected for the management fee/service income. They have also added construction in progress at 110% of cost. That could be overstated. Some developers are having trouble selling properties; therefore, the value of construction in progress may be falling and is certainly well below cost. Land values are dropping as construction costs rise, capitalization rates and mortgage interest rates are increasing, thereby reducing the potential value of the finished product. I doubt that the big four accounting firms are making the appropriate adjustments that are required to properly mark the assets and liabilities to market value.

The final sentence is also quite interesting in that Lehman Brothers is not adjusting the debt to market. Many real estate companies have short-term debt and other obligations that will have to be refinanced within the next five years. The cost of the refinancings will most likely be higher over this period, which means the cost of borrowing will increase.

Clearly, anyone involved with real estate knows that real estate investing requires a long term commitment to minimize the cyclical variations occurring in the market place. DCF analysis takes the long term into account, and is regarded as one of the best methods of replicating steps taken to reach investor buy/sell/hold decisions, and is often a part of the exercise of due diligence in the evaluation of an investment.”

Moreover, USPAP states that “DCF (discounted cash flow) analysis is becoming a requirement of advisors, asset managers, fiduciaries, portfolio managers, syndicators, underwriters, and others dealing in investment-grade real estate. These users of appraisal services favor the inclusion of DCF analysis as a management tool in projecting cash flow and return expectations, capital requirements, refinancing opportunities, and timing of future property dispositions. If pension funds and investors apply a discounted cash flow analysis to truly reflect the actions of buyers and sellers in the market place, then, why does Wall Street ignore the same? They too have a fiduciary responsibility, as well as an ethical obligation, to provide investors with meaningful conclusions that are explained, justified and supported by market evidence.

If other Wall Street firms are following similar procedures, expect further hits to some of the REIT shares as interest rates rise, construction costs increase and profits decline as indicated in my previous posting, “Is The Stock Market Signaling A Warning Sign To The Private Commercial Real Estate Market Or Was The Reverse True?” Wall Street appears to have forgotten many lessons that were learned in the 1970’s.

Thanks to Noreen Whysel who provided some input and assistance.

Tags: Soapbox Blog, James MacCrate, Straight from MacCrate

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