"From the peak in 2007 to its sale in 2009, the Bertelsmannbuilding has decreased 63% in value—and that's for a trophy NewYork City office building," says Jeffrey Rogers, president and COOof New York City-based Integra Realty Resources, which appraisedthe asset.

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As property fundamentals continue to wither, owners can eithersell their depreciated assets or hold onto them until the marketrecovers. But with so few sales to weigh against, those leaningtoward a trade are having a hard time pricing their properties.Even valuation professionals are finding the constraints of themarket challenging. Nevertheless, they are devising creativesolutions to appraise asset values.

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Hard Fall
Across the board commercial property values have nosedived 43.7%from peak 2007 levels, according to Moody's/REAL CommercialProperty Price Index. The ratings agency anticipates cash flows onassets with short-term lease structures, such as hotels andmultifamily, will bottom out this year or early 2011, while office,retail and industrial will take longer. Moody's forecasts prices tofall by as much as 55% in coming months.

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Then, says Moody's managing director, Nick Levidy, "Valuationswill rebound off the bottom and settle in for the longer term atlevels 30% to 40% below the market peak as liquidity and investorsreturn to the sector and property cash flows begin to recover." Butthat recovery of cash flows, he adds, may take several years.

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By property type, multifamily investors resold the most assetsin the past three months, with many averaging losses of more than30%, according to RCA. Office investors, who were also activelyreselling, saw returns range from a 45% gain to more than 60% loss.RCA attributes the disparity not only to the uncertain pricingenvironment, but also to a growing schism between core-stabilizedand value-add properties. And while retail investors flipped theirassets at discounts ranging from 2% to 25%, industrial and hotelinvestors largely let their assets go at double-digit losses.

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On the upside, however, some owners witnessed marginal gains ontheir investments in the last quarter. DRA Advisors netted a$12.8-million profit last November through the sale of RavinaCenter, an 804,876-square-foot office building in Atlanta. And withthe sale of its 834-unit Chelsea Ridge apartments in WappingersFalls, NY AIMCO realized a $31.5 million return on investment.

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Reworking the Model
Uncertainty in the market has certainly made valuationschallenging. Owners looking to sell or merely assess the worth oftheir assets must do so in a market lacking much of the requireddata metrics. A dearth of comparable sales activity in the past twoyears, in particular, has made it difficult to find benchmarks toestimate market value accurately.

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Appraisers traditionally employ three methods of valuation: thesales comparison approach, the cost approach and the incomeapproach, explains Peter S. Brooks, executive director of Ernst& Young's transaction advisory services in New York City. Thecost approach emphasizes the price of replacement, while the incomeapproach involves the initial capitalization rate derived from anasset's cash flow.

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In the absence of trade figures, Brooks stresses thesignificance of cash-flow analysis. This mark-to-model approach, asit has been popularly branded, differs from mark to market, inwhich market prices are used to calculate values, losses orgains.

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"You can construct an income model relying on some sort ofexternal evidence and use that as the primary basis of valuation,"he explains. "The model should be a good faith attempt to do what atypical market participant would do when estimating the income,expenses, discount rates and cap rates."

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To devise a substantive value model, Leslie P. Sellers,president-elect of the Appraisal Institute, encourages appraisersto look at property listings. "Listings are telling us what'scurrent in the market, what's competitive and what buyers andsellers are thinking," he says. "We can adjust past sales formarket conditions and continue to use them. But the most currentdata is what informs us in a changing market."

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Sellers says besides reviewing existing listings, it's importantto look at the offers on those listings as well as failedcontracts. In doing so, he stresses that appraisers must verify thedata by interviewing the buyer and seller to ascertain theirmotivations, the pricing process and transaction terms.

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"The sale price is not always the true sale price," Sellerssays, noting that an asset's ultimate cost is derived from manyfactors. Appraisers, he says, must ask if the seller offeredincentives, such as below-market financing, which could raise thefinal price.

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To read the complete version of this article, please go toReal EstateForum.

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