During this global pandemic, the best thing to do for both personal and business entities to keep a level head.
While nobody knows at the moment when or how this will all come to pass, we must make sure to protect all assets from any untoward damage and devaluation.
While it is not far from reality that real estate will be affected by this global crisis, there are reasons and tools you can use to make the valuation as conservative as possible so that the owner, buyer, and agents will all get a fair amount when closing a deal.
To start, valuing real estate is difficult even in “normal” situations. This is simply because there are plenty of factors to consider before getting its real value.
The location, size, floor plans, amenities, and the likes are just a few things compared to the many things that are to be considered when valuing a property.
So what should real estate investors and agents check on to keep the value right on their appraisal? Here are some things and thoughts to keep in mind.
What are these tools?
Currently, and contrary to current belief, the ﬁnance industry does have sufficient methodologies and tools to measure and forecast future real estate activity and values that may result from Covid-19. Here, an ordinary “before and after” analysis is a required valuation starting point to measure Covid-19 impacts. Unfortunately, as of today, there is no “after” scenario since we are still in the current spin cycle, with no clear outcomes visible on the horizon.
Simple Useful Tools
Thus, interim steps need to be applied. Investors and analysts should apply:
- A simple “present value” analysis whereby if no material changes to the property are likely, then the pricing adjustment is simply the recovery time required at a market yield rate for each asset. Assets in this category are likely to be in the top-tier industrial or multi-family category.
- If more complex factors exist (pending debt maturity; tenant rent payment issues; vacancy spike; etc.), then the “present value” concept applies. However, it must be adjusted for those added factors that are at risk.
This can be accomplished on a “percentage basis” (adjusting the risk rates) or on a “cash basis” (defining and quantifying all the various loss factors). In this analysis, these value adjustments are subtracted from the prior reported value (“before” the pandemic) to arrive at a “Covid-19 impacted value”.
In this context, a simple analysis of the relative weights of cash flow value (and duration) to aggregate property value would be helpful here.
Real estate value is a combination of two components: 1) Cash flows (operations); and 2) Capital Markets (cap and yield rates). Today, most industry analysts are reporting that cap/yield rates are expected to increase 25-100 bps, with specific assets and “food groups” having different changes based on industry as well as property specific factors.
When such a simple change is divided by, say, a 5% benchmark rate, a value swing of 5-20% (.25/5; 1/5) occurs. If added analysis illustrates that cash flow would result in a 5-10% net revenue loss, and cash flow is, say, 40% of PV, combined (and added loss of 4% say) value loss of 10-25% can be expected and defended readily.
3. From the lending side, all loans and equity partnerships moving forward will need to be “tranched”, as compared to just those that have historically gone through Wall St. Examples here include splitting all aspects of the investment into categories (both debt and equity) and weighting the outcome probabilities within such categories.
Each component of an investment will have a different risk profile and will need to be “tranched”. In effect, this is a weighted cost of capital structure and applying it to key project variables. Overall, this will have the net effect of lowering loan to value ratios…or increasing investor yield requirements. In the aggregate, we note that the Covid-19 impacts are expected to be greater than historical levels.
As you have seen, there are plenty of level-headed tools to use to give a fair and the “right” valuation of land even during and after the Covid-19 pandemic.
While there are plenty of things still needed to sort out this global issue, real estate will still be among the best investments to make because of its natural value.
With the new normal being implemented, a new normal for real estate will also ensue and followed which will bring new light to transactions and the living conditions of people in any neighborhood or business district.