What is it worth?

We recently invited a respected appraisal company to speak to our commercial brokers. We are in one of those periods where the old rules of value do not apply. Lately an appraisal is only viewed as representative of the correct value by one party to any transaction. If the appraisal is high, then the seller will quote it as gospel. If it's low, then the buyer becomes a convert. But who really knows right now.

It use to be, back in the 'good ole days' that as commercial agents we could use three methods to value a property, and depending on your belief in the strength of the under-lying numbers, one would lead you to the correct value. For this discussion we will not discuss 'Highest and Best Use' of the property. We will assume we need to value for purchase or sale and its use will not change.

The appraisal company's position was, "when the majority of the comparables are 'shorts' and foreclosures, those prices become the comparable." He specifically said that the three methods of valuing commercial real estate are not valid in this market.

Here's a recap of the three methods and my thoughts on each.

Cost Approach - considers the current cost to reproduce a property minus 'wear and tear.' This assumes that a savvy investor would not pay for an old building if they could build new for the same or less. This was sound logic, when we had builders who had a normal work load and charged a fair price. With building work scarce, some are asking less than a fair rate. Maybe they want to use up materials or just have some cash flow, that might lead to more projects. This method is not consistent right now.

Income Approach - considers that a close relationship exists between the income a property produces and its value. This was my favorite, and seemed to me to be best when used by investors who were looking for a return. The problem now is that all tenants are asking for reduced rent. Most landlords have figured out that it is better to have some income, rather than none. So if and when we recover, the rents may or may not return. Do you rate value on current income, or lease contracts. Tricky at best, and hard to place the right value at this time.

Sales Comparison Approach - considers value to be a reflection of what other buyers are paying for similar properties. The problem with this is that most properties in commercial are different and the motivation of each buyer and seller is also different. Most buyers are demanding a bargain. Sellers want to avoid bankruptcy, others want some cash so they may hold on to other properties. Not many are selling now to get a good price. So, this method, which is the one the appraisers must use, is unreliable.

If you consider that our values might have been inflated by the idea you could buy anything, for any price, and still make money, then perhaps those values were wrong before we got into this mess. There was a greed and haste that led us down this path. Is this where we should be, or is it just an adjustment period correcting what was wrong before? Either way. it will work itself out, eventually. Business purpose leads to commercial sales, and when the bargains are gone, and the economy improves, then optimism in a business venture will draw investors and business users back to the market to chase income opportunities.