A question of value.

Author:Collins, Webster A.
Position:Valuation of real estate in the current crisis situation - Cover Story

A major topic of discussion in and out of the real estate industry today is the issue of value. This article will explore value issues, outline trends and present a perspective on how value is looked at today.

Is true that all industries, at times, have problems. Back in the mid-1970s, properties that experienced downturns in income could be financially restructured. Mortgage rates could be reduced to the level of net income, participation features added, and, as the market recovered, lost interest could be repaid, participation received, and the mortgage could be paid off through refinancing. The basics of the real estate industry had remained fundamentally unchanged for decades, and there wasn't any need to "teach an old dog new tricks." Over time, the majority of the mid-1970s workouts became successful ventures. Then the market turned, and we entered the 1980s.

The 1980s: a period of transition

Beginning in the late 1970s and going into the next decade, changes occurred that have had a major impact on today's real estate markets.

One such change was the deregulation in the 1980s, which allowed the nation's thrifts to "go public" and raise vast sums to be loaned on real estate. Also, depreciation schedules were dramatically changed with the 1981 tax act, and liberalized write-off schedules remained in place until 1986, allowing depreciation periods of 15 to 19 years. It is well known that commercial property value is measured by the present worth of future benefits. With the tax change, a new benefit developed in the form of the value of depreciation, or alternatively, the syndication proceeds that could result.

On the technology front, computer programs popularized discounted cash flow studies. The availability of computers to most developers, lenders appraisers and others led to many misuses and abuses by those real estate analysts who were inexperienced with the techniques.

Real estate holdings became increasingly national, giving rise to problems such as faulty analysis of variations in local markets and their driving forces and differing valuation techniques applied to various property types and locations. Problems such as these were addressed by the formation of appraisal network organizations to answer to need for national appraisal services offering a combination of local market expertise, consistent appraisal techniques used by each local expert and sound judgment in analyzing data.

Finally, with demand for real estate space rising to levels not seen in 50 years, the real estate development community, funded by public pension funds and others, created hundreds of millions of square feet of space.

What was forgotten in the midst of all the building and buying frenzy was that employment is the principal driving force behind the demand cycle. With a decline in employment, markets can quickly crash when they become overbuilt. This happened first in Houston, where signs were evidents in the early 1980s when 100,000 jobs were lost, and there was an excess supply of roughly 45 million square feet of space.

Real estate markets in other areas of the country also crashed as employment growth declined and then actually shifted to a negative number. For example, by mid-1986, it was obvious that overbuilding was occurring in the Boston area. But it was impossible to predict at that time the depth and severity of what has since occurred there.

Analysis of a market crash: Boston

In mid-1986, I published an article (Appraisal Views, July 1986) titled "Even in Boston, Lights Turn to Caution." At that time, downton Boston had been among the nation's strongest downtown office markets for a decade. During the period of 1976 to 1986, the downtown office market had more than doubled its size, with vacancies averaging less than 5 percent and...

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