By Cliff Hockley, President of Bluestone and Hockley Real Estate Services
Executive Director, SVN | Bluestone and Hockley
Real estate appraisers in Oregon, are carefully threading the needle of real estate valuation, as they assess the COVID-19 coronavirus and its impact on real estate supply and demand. We know, COVID-19 has created some short-term anxiety for the financial institutions. Lenders are looking for some way to manage their risk, given the challenges of returning to work safely and reemploying those that have been sent home. Financial institutions have shifted their lending priorities from standard real estate lending to business lending because the federal government needed to use them as a conduit for PPP and to help boost the US economy.
In the meantime, these institutions have either withdrawn from existing real estate loan commitments, stopped lending altogether, or limited their lending to clients who are very strong and are willing to increase their down payments, which has limited their exposure to the vagaries of non-rent paying tenants.
Lenders have turned to real estate appraisers to help manage their risk. Appraisers have stepped up and, in many cases, made adjustments to their current appraisals.
Some of the appraisal adjustments are chronicled listed below:
- Increase CAP rate estimates (due to estimated lack of rental income or lack of buyer demand) which inevitably reduces property valuations
- Adjustments to lower values due to lower actual incomes
- NOI adjustments (Both by estimating increased expenses and lowered income)
- Using verbal quotes from real estate brokers; that reflect a slowed real estate marketplace
- This then gives shelter to appraisers to make additional “adjustments to lower the appraisal value”
- Delete the cost approach from appraisals as not being relevant
- Ignoring relevant near-term sale comps
- Increase the weighting of appraisals to the low end of the income approach
Appraisers have focused on the following appraisal adjustments in the following real estate categories.
Selected Food Groups:
Apartments – appraiser adjustments:
- Typically, are adjusting values downward by 5% due to COVID
- Adjusting values depend on collected rents over the last two months
- CAP rate deductions to reflect more conservative adjustments
- A good location will see fewer adjustments
- Quality of income is considered as well
- Looking at recent trades in the marketplace for properties that were in escrow and then had prices reduced – typical price reductions 2 – 4.5%
- Holding at 5% Vacancy for most properties except for ones with rents at the high end and low end of the marketplace which seem to have a higher vacancy rate
- There seems to be a flight to quality
- There might be a one-time adjustment to scheduled rents of up to 10% over six months
Owner user Buildings:
Typically financed using SBA guaranteed loans.
- Appraisers A and B indicated no deducts to value and are appraising properties at market values that existed before the pandemic.
- Value is driven by occupancy and given that many hotels still have low occupancy. Which means they are having trouble getting appraised and financed. That is changing though, at some selected properties as Americans are traveling by car across the country to visit families.
- Appraisers reflect that reductions in actual rent about 70% of the rents have been collected in neighborhood retail centers.
- Reflect significant increases in CAP rates up to 1.5% to reduce value.
- Quality of tenants – i.e. local or national makes a difference. Many national tenants are not paying rent, and local ones are.
- Appraisers have not yet figured out how to deal with lease adjustments where rent is added back into the income flow, over a period of time, either over the next 6 months or at the end of the lease term.
- More confusing is that many tenants paid their full rent obligations after they received their PPP Funds
- Appraisers are looking for feedback from brokers – who really only know that sales of properties have ground to a halt, temporarily.
- This depends on the property and quality of tenants – National tenants have paid their rents.
- Regional tenants had more trouble till PPP funds showed up.
- Appraisers made income and CAP rate adjustments downward to reflect the reduction in income.
This is a challenging and unclear area:
- 90% + of the tenants are paying their rent.
- But most if not all the employees are working from home.
- It is not clear that they will be coming back to work in the office.
- Clearly there is pressure from employees to work from home because they do not want to commute to work.
- Employers are also finding that in fact, they can effectively run their operations without meeting in office space, using Microsoft Teams, Zoom, Ring Central, GoTo Meeting, or some other similar online group conferencing software.
- Employers have been looking for ways to lower their overhead. COVID has given them the opportunity to send employees home. They will be looking for a way to continue this experiment.
- Appraisers are discounting office building values for investors to hedge that risk.
The bottom line is that appraisers and financial institutions are looking for ways to keep lending but at the same time mitigate their risk. It is risky when a significant number of tenants do not pay their rent and in turn, Landlords cannot pay their mortgages.
Banks are only motivated to close or refinance deals with properties that are well tenanted; where all of the tenants have paid the rent or with buildings that are used by the borrower. Appraisers can safely evaluate that risk. Borrowers should expect appraisal value discounts in all real estate categories depending on rental receipts generated.
Buyers need to expect to increase their down payments to get both owner user and investment deals closed. Given the pandemic expect fewer buildings to appraise at the sale price that may have been negotiated in February of 2020.