Asset Management in a Down Market: A Suggested Valuation-Underwriting Process Page: 2
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At the same time, the price of the fac-
tors of production is influenced by the
general market of producers competing
for the same resources. Real estate devel-
opment forces up the price of labor, archi-
tecture, materials, the interest rate and so
on. Real estate is developed at a high
price because its perceived return is high.
The relationship of the commodity to
factors of production holds if supply and
demand in all markets are in equilibrium.
Smith recognized this as possible in the
long run, and he called this value the nat-
ural price.3 Today it is called market value.
The problem at any given time is that
supply and demand for the commodity
and the factors of production might not be
in equilibrium. Disequilibrium is repre-
sented by a short-term market price that
is above or below its long-term market
value. The dilemma for the appraiser and
underwriter is that the productivity and
thus the cash generated by a specific en-
terprise might differ from general market
perceptions at any time. This dilemma
forms the classic dichotomy of asset fun-
damentals versus market activity and has
plagued real asset and financial asset in-
teraction throughout history. A solution to
the difference might be found in the way
financial contracts are structured for the
asset.
Valuation-Underwriting Model
Given the theory of distribution, many
real estate problems can be considered
as multiple levels in veneer. By looking
at layers of the problem, several assets
can be identified in any real estate
transaction.
The varying risk contingencies lenders
traditionally have dealt with in real estate
loans may be considered as different fac-
tors, resources, assets or commodities
themselves. These components may havevalues and risk levels that differ from the
actual real estate product. Lumping a
composite asset into one residual product
helps explain why many people in finan-
cial distress expect to be bailed out by
real property.
During periods of inflation, reliance on
real estate may not be unreasonable. In
the current down market, however, it has
led to a dumping of properties on the
market, often via foreclosure.
The proposed alternative valuation and
underwriting requires identification of
component assets and their risk levels.
The following valuation case illustrates
refinancing of a successful property penal-
ized by institutional procedure in a down
market.
The property is an apartment complex
located near a major state university. It
has had a 98 percent occupancy rate
throughout its ten-year history. Its two
most recent years of operation were suc-
cessful despite the distressed economy. By
appraisal standards (especially to fit the
"Fannie Mae" form) the property must be
compared to various market standards,
such as a 33 percent vacancy. Also, the
property must be appraised using a con-
cept of market or economic rent. The con-
tract or actual rent has been above mar-
ket level for the last four years.
Economic rents are used in appraisal,
but appraisers often give actual expenses
more weight than market standards. This
weighting is done if the actual expenses
are higher because appraisers perceive a
problem with the property or its manage-
ment. Part of the success of the project
has been its high standard of maintenance
and repair that resulted in above-market
operating expenses and reserves for re-
placement and repairs. The net result of
using a market standard for rent and an
above-market standard for expenses is a
lower net operating income (NOI) than may2
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Grissom, Terry V. Asset Management in a Down Market: A Suggested Valuation-Underwriting Process, report, January 1989; College Station, Texas. (https://texashistory.unt.edu/ark:/67531/metapth653368/m1/8/: accessed July 17, 2024), University of North Texas Libraries, The Portal to Texas History, https://texashistory.unt.edu; crediting UNT Libraries Government Documents Department.