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One Step Further. Practical Implementation of Guide Note 12. The Problem.
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One Step Further Practical Implementation of Guide Note 12
The Problem • Equilibrium - The theoretical balance where demand and supply for a property, good or service are equal. Over the long run, most markets move toward equilibrium, but a balance is seldom achieved for any period of time.
The Problem • Real estate markets characterized by cycles (gradual or boom-and-bust) • An appraisal can quickly become outdated
The Problem The Appraiser’s Role: • The appraiser’s perspective • The client’s perspective Point of Agreement: • Value at a single point in time may not be adequate for some intended uses
The Solution – Guide Note 12 • Two risks in use of an appraisal: • Value opinion is unreliable due to lack of quality data (or analysis) • Value might not be sustainable over time
The Solution – Guide Note 12 • Factors of change vs. symptoms of change • Capital markets and fundamental markets each cause markets to change • Market analysis (6 steps) allows the appraisal to be forward looking • Unforeseen events can invalidate conclusions of market analysis
The Solution – Guide Note 12 • As appropriate, reconciliation should discuss the likelihood the value might not be sustainable into the foreseeable future
Concerns about Guide Note 12 • Predictions are not meaningful • Risk of a lawsuit • Clients will not like it • More work with no additional compensation
Real Estate Market Cycles • Capital markets • Equity capital (investors) • Debt capital (lenders) • Fundamental markets • Space users
Tools for Analyzing Cycles • Entrepreneurial Incentive • Minimum necessary to justify construction • Not potential profit at a given point in time • Concept of positive external obsolescence • Challenges to application
Tools for Analyzing Cycles Frictional Vacancy – vacancy unrelated to disequilibria in supply and demand… a typical vacancy rate in a given market operating in equilibrium.
Tools for Analyzing Cycles Feasibility Rent – the rent necessary to justify new construction. • When the market is at equilibrium, the rental rate for new, fully functional space is equal to feasibility rent.
Tools for Analyzing Cycles Equilibrium Rent – what market rent should be for a subject property, assuming the market is at equilibrium (hypothetical)
Tools for Analyzing Cycles Affordability Analysis Affordability Index – a measure that indicates potential buyers’ ability to purchase a home
Tools for Analyzing Cycles • Market Analysis (6 step process) • Property productivity analysis • Market delineation • Demand analysis • Supply analysis • Marginal demand analysis (comparison of supply & demand) • Projection/forecast of subject capture
Contraction Expansion Equilibrium Equilibrium Recovery Recession Midvale Office Market Reporting Conclusions Midvale Office Market
Analyzing Capital Markets • Equity market • Capitalization rates and yield rates • R = Y - CR • Debt Market • Interest rate and terms • Underwriting criteria (LTV, • Marginal demand analysis (comparison of supply & demand • Projection/forecast of subject capture
Conclusions One step further called for by Guide Note 12 means: • Appraisal becomes more valuable tool • Future of appraisal profession is brighter