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In recession, commercial brokers struggle to determine property values

May 25, 2009

Few commercial real estate properties are changing hands in the Indianapolis area these days, creating challenges for brokers who say it's becoming increasingly difficult to determine the value of properties.

With the economy in turmoil, and the acquisitions market at a virtual standstill, only a handful of recent sales can be used to guide appraisers and brokers in attaching a dollar figure to office, retail and industrial buildings up for sale.

The problem is delaying transactions, complicating negotiations with lenders, and prompting a a host of new questions for both buyers and sellers looking to make a deal.

""How do appraisers value property where there's no data, where there's no market activity?" asks Ross Reller, a senior adviser at Resource Commercial Real Estate. " "Are they allowed to go back a year? Are they allowed to o go back to a time when the market was different?

"There's really not a a good answer."

The issue is uncertainty in the marketplace, said John Robinson, a principal in the local office of Jones Lang LaSalle.

Most large commercial property sales came to a halt at the end of 2007, and the pool of capable buyers has dwindled significantly.

Now, every capable buyer is shopping for bargains and questioning a property's worth, Robinson said.

"Basically,, there's total chaos in the marketplace right now," he said. "Chaos in the marketplace doesn't lead to lots of transactions getting done because nobody knows if they're getting good deals or not."

Major office buildings that went on the market last year but never sold—including the five-story, 100,000-square-foot 8500 Keystone Crossing site—came to a standoff over price and values, Robinson said.

"You had sellers with 2007 price expectations and you had buyers with 2010 price expectations," he said, "and the [two] didn't meet."

Determining value


Coming to an appropriate value for a commercial property typically involves a range of factors, said Nick A. Tillema, a commercial appraiser with the local firm Access Valuation.

For newer buildings, appraisers calculate the construction price to determine what it would cost to build new.

Another common practice is the income approach, in which appraisers determine how much net income the building can reasonably expect to achieve in the future.

But nearly all appraisal decisions involve a look at comparable sales within a six-month period, Tillema said. The dearth of information in that regard is complicating appraisers' jobs, he said.

Appraisers don't typically include foreclosed or distressed property deals in comparisons, but may be forced to do so with so few conventional sales occurring, Tillema said.

Concern about a possible wave of commercial property foreclosures is only adding to the confusion over values.

Banks, fearing additional defaults, are clamping down on lending, which is contributing to the lack of market activity, Resource Commercial's Reller said.

"We're in kind of what you call an ether world where nothing's happening and no one knows the value of anything because no one is stepping up to tell us what they think things are worth," he said. "What we're left with is a market that is not functioning; commercial real estate is just not changing hands."

Reller took a course on appraisals recently to better understand the process. He said many brokers are in "uncharted waters" and must price properties using data from years past.

"What we're trying to do is look at the arms-length market transactions, of which there is a reduced number," he said. "It is making our job much more challenging."

Distorted property sales

What's more, brokers say many cash-strapped property owners are increasingly accepting heavily discounted deals to avoid defaulting on their mortgages.

When that happens, the values in the market become even further skewed, said Tim Norton, of Summit Real Estate Group.

Norton pointed to a 50,000-square-foot Class A office building in Carmel as an example. The building's true value, based on historical comparisons and replacement costs, should stand at $4.8 million to $5 million.

Yet, he said it would likely sell in the $3 million range because the building owners need to cover an upcoming debt payment and want to avoid losing the property.

Norton declined to disclose the exact location of the property, citing his involvement in sensitive negotiations.

Lenders play a significant role in the value equation, he said, as financial institutions become increasingly active in determining the health of properties.

Norton said many lenders are now reviewing each commercial building's tenants to evaluate their financial performance and the likelihood of future success.

Estimates on decline

With little sales information available, can brokers estimate the extent of the commercial property value declines locally?

Robinson, of Jones Lang LaSalle, said some simple math shows that property values likely have fallen 30 percent to 40 percent among Class A and Class B office and commercial properties. The plunging values relate directly to the changes in the financial markets, he said.

Consequently, property values must decrease, Robinson said.

The decline in values doesn't represent fundamentals of the Indianapolis commercial market, which remain strong, Robinson said.

"The value is 100-percent related to the changing in the debt markets," he said. "It's a lending issue; it's not a market issue."

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