Q: You have been stating that the income and expense figures for the Sale 4 comparable are estimates, but the report states “…the buyer reported cap rate of 4.87%, gross potential income of . . . etc" I read this to say that the buyer provided all the figures versus the figures being estimates. Am I misreading? The vacancy factor is not a "standard" figure; i.e., 5%, but is rather 34%, which also leads me to believe the figures were provided by someone versus being estimates. What are your thoughts?
A: You have a very good point and I suspect you’re right. We know NOI for the Sale 1 comparable is an estimate based on the sales price and a cap rate provided to the appraiser. The data listed for Sales 2 and 3 appears suspect because of the neat 5% vacancy rate. But you can indeed argue that the data listed for Sales 4 – at least the effective gross income and the operating expenses that provide the NOI amount – may reflect actual events. The vacancy loss seems suspect – an estimate based on full occupancy at assumed rental rates – as does the resulting potential gross income number.
Historical NOI is the difference between effective gross income and operating expenses. If the appraiser has that actual data in hand for the comparables, then the net operating income amounts will reflect events rather than assumptions and the cap rate implications should be far more accurate.
Q: What is the benefit of using a gross income multiplier to value a property versus NOI per unit?
A: It’s a reality check, in effect. In this instance the appraiser used three methods in attempting to arrive at an estimate of market value using the sales comparison approach – price per unit, NOI per unit, and the gross income multiplier. They all relate back to the sales price, which is the basic measuring stick. The appraiser may, in effect, reconcile the three methods, i.e., average them, to arrive at an estimate of market value.
In this instance, the appraiser states that he or she gave primary weight to the price per unit estimate – which provided an estimate of market value of $5,586,000. In fact, the gross income multiplier at an estimate of $5,598,825 provided the estimate closest to the value chosen by the appraiser – $5,600,000. The appraiser, in turn, provided no reason for his or her comment about placing primary weight on the price per unit results.
Q: With respect to the “Cash Flow Access in Default” slide, what is your opinion on the subject of self-executing attornment language in a lease agreement (or non-disturbance language, for that matter) versus having a separate legal document signed by the tenant, borrower, and lender, even if that language is contained in the lease agreement? Does having a separate agreement provide better/easier access to property cash flow in event of a default?
A: As a general rule, simpler seems better than complex. A lawyer would likely argue that a second separate document would provide better assurance that there is no other clause in that separate document that would inadvertently weaken the language of the attornment provision – which may be a potential problem for a catch-all document such as a lease agreement. My preference would be a single document, well vetted. But it's always wise to check with a lawyer.
Q: An observation. Earlier you made a case for looking at comparable sales information versus changes in the prime rate over time. My view is that CRE pricing is far more dictated by movement in the Treasury yield curve, especially if you look at the curve five to ten years out. While, clearly, increasing or decreasing borrowing rates over time should enter into the analysis, how do you reconcile the concept of prime versus Treasury yields?
A: We used the prime rate to make the point about significant change in a short period of time. I wanted everyone to be sensitive to this issue of comparable transaction dates and the possibilities of material change in a short time period. The prime rate aside, 10-year Treasury yields fell from 4.69% to 3.74% over that same time period – not as dramatic as the drop in the prime rate but still quite impressive and certainly indicative that events can change very rapidly.
I agree completely about Treasury yields setting the reference rate for CRE pricing. That seems to be a well established practice. Many CRE transactions are, indeed, price over the 10-year Treasury bill yield.
Re the prime rate versus Treasury bill rates, one does follow the other in general, but the key factor seems to be short term versus longer term expectations about rate movements and events in the economy and financial sector. In normal times, long-term Treasury yields should be above short-term prime, simply to reflect the risk factor and the time value of money. But we're certainly not in ordinary times today.
A: You have a very good point and I suspect you’re right. We know NOI for the Sale 1 comparable is an estimate based on the sales price and a cap rate provided to the appraiser. The data listed for Sales 2 and 3 appears suspect because of the neat 5% vacancy rate. But you can indeed argue that the data listed for Sales 4 – at least the effective gross income and the operating expenses that provide the NOI amount – may reflect actual events. The vacancy loss seems suspect – an estimate based on full occupancy at assumed rental rates – as does the resulting potential gross income number.
Historical NOI is the difference between effective gross income and operating expenses. If the appraiser has that actual data in hand for the comparables, then the net operating income amounts will reflect events rather than assumptions and the cap rate implications should be far more accurate.
Q: What is the benefit of using a gross income multiplier to value a property versus NOI per unit?
A: It’s a reality check, in effect. In this instance the appraiser used three methods in attempting to arrive at an estimate of market value using the sales comparison approach – price per unit, NOI per unit, and the gross income multiplier. They all relate back to the sales price, which is the basic measuring stick. The appraiser may, in effect, reconcile the three methods, i.e., average them, to arrive at an estimate of market value.
In this instance, the appraiser states that he or she gave primary weight to the price per unit estimate – which provided an estimate of market value of $5,586,000. In fact, the gross income multiplier at an estimate of $5,598,825 provided the estimate closest to the value chosen by the appraiser – $5,600,000. The appraiser, in turn, provided no reason for his or her comment about placing primary weight on the price per unit results.
Q: With respect to the “Cash Flow Access in Default” slide, what is your opinion on the subject of self-executing attornment language in a lease agreement (or non-disturbance language, for that matter) versus having a separate legal document signed by the tenant, borrower, and lender, even if that language is contained in the lease agreement? Does having a separate agreement provide better/easier access to property cash flow in event of a default?
A: As a general rule, simpler seems better than complex. A lawyer would likely argue that a second separate document would provide better assurance that there is no other clause in that separate document that would inadvertently weaken the language of the attornment provision – which may be a potential problem for a catch-all document such as a lease agreement. My preference would be a single document, well vetted. But it's always wise to check with a lawyer.
Q: An observation. Earlier you made a case for looking at comparable sales information versus changes in the prime rate over time. My view is that CRE pricing is far more dictated by movement in the Treasury yield curve, especially if you look at the curve five to ten years out. While, clearly, increasing or decreasing borrowing rates over time should enter into the analysis, how do you reconcile the concept of prime versus Treasury yields?
A: We used the prime rate to make the point about significant change in a short period of time. I wanted everyone to be sensitive to this issue of comparable transaction dates and the possibilities of material change in a short time period. The prime rate aside, 10-year Treasury yields fell from 4.69% to 3.74% over that same time period – not as dramatic as the drop in the prime rate but still quite impressive and certainly indicative that events can change very rapidly.
I agree completely about Treasury yields setting the reference rate for CRE pricing. That seems to be a well established practice. Many CRE transactions are, indeed, price over the 10-year Treasury bill yield.
Re the prime rate versus Treasury bill rates, one does follow the other in general, but the key factor seems to be short term versus longer term expectations about rate movements and events in the economy and financial sector. In normal times, long-term Treasury yields should be above short-term prime, simply to reflect the risk factor and the time value of money. But we're certainly not in ordinary times today.