The Market Must Return To Fundamental Analysis

Property values have declined by more than 40% due to a triple hit of lower rental revenues, increases in vacancy and higher rates of return. This has raised questions about the over building that occurred in so many property segments, and why real estate lenders, investors and appraisers did not see the potential problems. A review of many failed projects over the past several years reveals cases of limited market analysis supporting the feasibility of developments and key metrics that were often ignored.

A number of projects were fueled by cheap capital, which accelerated the rate of development. Financing for these projects was based on a review of the rents, occupancies and operations of nearby comparables with limited analysis of demand. A mindset evolved that real estate values only appreciate and value declines were a thing of the past. There was a perceived paradigm shift away from historic real estate cycles.

Now with many markets in disarray, participants are left with the task of trying to get out of this malaise. With limited demand for many property types, forecasting absorption and value is challenging. Lease-up forecasts based on a review of recent demand trends often represent multi-year timeframes that on the surface appear unrealistic. Real estate markets are cyclical and durations of cycles vary from more than one year to possibly 10 to 12 years. During the recessionary stage of a real estate cycle, complications occur when forecasting demand. Many markets are overbuilt and negative absorption has been prevalent for the past two years. However, ignoring long-term fundamental market analysis on these properties is just as dangerous as not adequately analyzing these projects when they were initially proposed.

Proper market analysis requires a detailed review of current and historic supply/demand relationships. This type of analysis requires real time access to market sources for both current and historic data. Key market studies vary by property type and include, but are not limited to, RElS, Loop Net, Real Capital Analytics, lCSC, Economy.com and numerous other regional and local market reports.

Key data provided in these reports often include the amount of market inventory, proposed new inventory, current and historic space absorption, office employment growth and critical demographic data. These sources also provide figures for rents and occupancy that support project feasibility and overall market trends, as well as give a macro economic overview and a micro or submarket overview. This information is then processed and augmented with a primary competition analysis as well as a review of proposed developments that could impact a particular property.

Another key research technique that is paramount in todays tumultuous markets is to interview active real estate brokers and investors to ascertain current market trends. A positive development for many markets is that construction has ground to a halt for most property types. Long-term, this trend should bode well as it will allow time for many markets to absorb existing inventory until new development is warranted. Fundamental market analysis is critical to making informed decisions. It is a key value-added service that helps provide quality quantitative market analysis to enhance property decision making.

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