APPRAISING CHANGE estate market value from the going concern . It ’ s not just a legacy hotel or restaurant with business enterprise value to consider in 2022 . The breadth of property types with going concern value has expanded and some adjustments are required , including :
1 . Extract Non-Realty from Sales Transaction Comparables . When determining the real estate market value , non-realty components — such as the cost of moving trucks or fixtures constructed for specific uses — must be adjusted for or extracted from the total transaction sale price .
2 . Market Rent and Occupancy . The objective in a market value determination is to estimate the average market rent and occupancy versus a specific property ’ s operating rent and occupancy that could be influenced by other factors , like “ weeks versus points ” pricing in timeshares or inferior or superior amenities and services as in the case of climate- versus non-climate-controlled self-storage .
3 . Management Fees Don ’ t Capture All the Going Concern . Consider the revenue contribution and expense-side accruing to going concern value from any additional off-site services ( advertising , IT and tech support , accounting , security monitoring , etc .) that may be above what is generally seen in the market . A general 3 , 5 , or even 10 percent overall management fee often doesn ’ t cover the expenses for the business services not related to the typical 3 to 5 percent property level management for physical maintenance and onsite management .
4 . Distinguish the Going Concern Cap Rate in a Transaction . Selecting a cap rate requires judgment and a breakdown between the asset classes ( tangible real estate , intangibles , and financial assets ). Of significant note on this point is Chapter 37 in “ The Appraisal of Real Estate , 15th Edition .” REIT and portfolio transactions often utilize a purchase price allocation ( PPA ) to segregate the non-realty , property-by-property market value for the real estate and use these transaction price allocations for SEC and GAAP accounting reporting . Be sure to inquire about the PPA with the buyer so as not to misrepresent a pro rata of the portfolio sale with non-realty attributed to an individual property in the aggregate transaction .
Self-Storage Industry Ownership
Industry Ownership |
2019 |
2020 |
Change |
Public Operators ( REITs ) |
27.6 % |
31.2 % |
3.6 % |
Top Operators ( minus REITs ) |
19.4 % |
16.5 % |
-2.9% |
All Other Operators |
53 % |
52.3 % |
-0.7% |
Source : 2021 Self-Storage Almanac |
|
|
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5 . Don ’ t Overlook the Cost Approach . The cost approach is integral to the principle of substitution and is a reliable method to value just the real estate assets . Note the following from “ The Appraisal of Real Estate , 15th Edition ”: In situations where the cost approach can be developed reliably , it can be useful in determining the appropriate allocation of value to the different
Brokers , CRE investment advisers , and appraisers collectively need to understand how ESG scoring is going to impact all aspects of the CRE transaction process .
asset classes . A common strategy is to use the cost approach to value only the tangible asset classes ( land , sticks , and bricks ). The value indication from the cost approach can then be compared to value indications from the sales comparison and income capitalization approaches to highlight the inclusion of non-realty and intangibles to the going concerns .
ESG / DEI AS A VALUATION ELEMENT TO ADDRESS CLIMATE RISK AND DIVERSITY As mentioned earlier , ESG and DEI initiatives are now critical CRE factors . ESG scores by proxy advisers such as Glass Lewis and ISS — as well as CRE debt monitoring companies like Trepp — can make or break a transaction .
Several top-10 banks with CRE concentrations now incorporate a level of ESG underwriting to the commercial real estate credit approval process . A credit request based on a less-than-favorable ESG score influenced by a single tenant ( such as a firearms maker or fossil fuel company ) or a property ownership structure that lacks diversity can result in a negative credit approval decision .
The nationally recognized CRE debt-monitoring company Trepp has published extensively on ESG scoring and developed its own modeling that translates down to the individual property level . Trepp has also partnered with RMS , a Moody ’ s Analytics Company , to create a new composite environmental risk score based on the integration of RMS ’ s climate catastrophe risk models with Trepp ’ s CMBS and CRE products . This partnership will provide both a physical risk score and a business interpretation to properties listed in Trepp ’ s database . In the future , the partners plan to bring new scores and metrics focusing on enhanced risk measurement and add more granularity to facilitate analysis .
Brokers , CRE investment advisers , and appraisers collectively need to understand how ESG scoring is going to impact all aspects of the CRE transaction process from underwriting to capital allocation to market value . The ESG score may become more impactful on value than the selection of a cap rate .
CONCLUSION From the embedding of going concern and business value within more property types to the evolution of PAREA that could potentially replace the USPAP , a lot is changing in how commercial real estate value is determined . Whether you are a broker , appraiser , or investment adviser , how commercial real estate value is determined is more in focus in 2022 than at any point dating back to 1989 and the passage of the FIRREA legislation .
Don ’ t get caught off guard . Start getting prepared today for how CRE valuation will be conducted tomorrow .
K . C . Conway , CCIM , MAI , CRE Chief Economist for CCIM Institute
CIREMAGAZINE . COM COMMERCIAL INVESTMENT REAL ESTATE MAGAZINE 29