Asset Management in a Down Market: A Suggested Valuation-Underwriting Process Page: 3
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actually exist. This is a problem for a
lender when determining the property's
value for loan purposes because a debt
coverage ratio is often the decision crite-
rion. The debt coverage ratio bases the
amount of financing on the property's
ability to carry the periodic debt.4
The traditional approach reduces in-
come solvency and value. Reduced sol-
vency lowers the basis for refinancing the
property. The result is that a superior per-
forming property is penalized in the finan-
cial and real estate market.
Traditional appraisal and underwriting
are based on "typical or average" man-
agement, expenses, performance and so
on. Assumptions of mediocrity are ration-
al when seeking a conservative perspec-
tive. A conservative view might not always
be appropriate, however. Perhaps the ob-
jective instead should be the actual situa-
tion or problem. In terms of this case
study, the appropriate question to ask is
why the property is performing better than
the market. This inquiry is aided by exam-
ining the priorities that make up a prop-
erty or a business.
In his valuation techniques of the 1930s,
Babcock delineated income properties and
properties used in the production of in-
come. In the latter, business profits are
allocated between real estate and the
business.5 In Babcock's taxonomy, an
apartment is an income property because
it generates a return for the privilege of
occupying the space. A movie theater,
however, is an example of realty used in
the production of income. In this case, the
use of space is more akin to a license to
participate in an activity, but the real
estate itself is still an integral part of
the business.
The relationship of real estate to the
activities it houses helps explain why one
property performs better than the market
(especially a down market). Success canbe traced to a perception of uniqueness or
a monopoly for a given property. Certain
attributes such as location are recognized
as unique in an otherwise competitive
market. In this case, comparable analysis
revealed no locational pattern of preference.
No physical property attributes -other than
maintenance could be identified to explain
consumer preference for the subject
property.
Superior performance also results when
the property is marketed as offering more
than mere space. In this particular case,
management sells the notion of the life-
style associated with residents who are
primarily college students. This same enti-
tlement is possible at any complex within
the subject's trade area. Life-style is a
commodity over and above the shelter
offered by the property. It is not a cost
because management itself offers limited
recreational events.
If monopoly results from superior mar-
keting and management, then the tradi-
tional appraisal form is limited. Superior
returns might be the result of manage-
ment or entrepreneurial effort, in which
case comparison based on the assumption
of average management is inappropriate.
Implications of this alternative perspec-
tive are illustrated by an analysis of this
property under a traditional appraisal for-
mat and a format considering the theory
of distribution.
Traditional Appraisal Approach
The property is near a large university
and has 103 units containing a leasable
area of 51,500 square feet. The actual
rental return averages about $.65 per
square foot per month. The typical return
to the comparables in the area is $.53 per
square foot per month. Typical vacancy in
the area is 33 percent. The subject is 2
percent vacant. The subject has an ex-
pense ratio of 50 percent of gross income.
Five percent of the gross income is allo-3
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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/m1/9/: accessed July 17, 2024), University of North Texas Libraries, The Portal to Texas History, https://texashistory.unt.edu; crediting UNT Libraries Government Documents Department.