One dollar is worth fifteen

The following except was provided in a recent newsletter from John Temple, President of 1031 Property Watch. I felt the content was important and wanted to include it in our blog. He graciously agreed to allow us to repost it. John writes,

I just returned from a strategic planning meeting with the Tenant-in-Common Association (TICA) Board of Directors. It should come as no real surprise that the effects of the credit crisis that started in the second quarter of 2006 are being felt throughout the industry. Arguably, this real estate correction will take some time to work itself out. In the past 60 days prices have softened to the point where the average cap rate has risen 60 basis points, from 6.20% to 6.80%. This is good news for real estate buyers; however finding value will still require a sharp pencil and an experienced eye as prices continue to correct.

The market is also getting back to real estate basics. Properties are no longer being valued based upon speculative assumptions, but rather through predictable increases in net operating income (NOI). Solid increases in NOI will keep real estate performing over the next few years. I believe it will not only bridge this market correction, but is how a disciplined investor should invest over the long term.

Let me give you an example of how increasing the NOI can add value over time. Let’s say that a given property has an annual rent increase of 2%, for a total of 20% over ten years. Given a cap rate of 6.67%, a $1 dollar increase in net operating income will increase the value of the property by approximately $15. So if your property has an NOI of $100,000 and a rent increase of 2%, in ten years the value of your property would raise from $1.5 million to $1.8 million. In this example, a $20,000 increase in NOI moves the price up $300,000 dollars. This explains why experienced investors look for properties that can sustain long-term occupancy and support small steady increases in net operating income.

NOI / Cap Rate = Sales Price

If you would like a more detailed article on how NOI growth works or if you want more information on how this could affect your property, please give John a call at 877-337-1031. He can also be reached at john@1031propertywatch.com.

Real Estate Investments for a Slowing Economy

Matt Hudgins of National Real Estate Investor has written an excellent short article on the effect a recession in 2008 would have on real estate. He cites a Property & Portfolio Research report that indicates apartment properties, while more volatile in their net operating income during a recession, are better positioned to hold their value. In an odd dichotomy of the effect between net operating income and market-accepted capitalization rates, investors seem support capitization rates better on apartment properties versus other commercial classes of real estate during an economic downturn. Retail, the report says, are the most negatively impacted in a recession as consumer spending dries, lease rates fall and vacancy increases. Rather than restate the whole article, here is Matt's report.

In a November Marketwatch report, John Spence says analysts at UBS disagree somewhat stating that regional malls proved to be the best option during a downturn. He says they held values better and showed their defensive qualities during the last consumer-led recession in the early 1990s. The resilience of consumer spending and patience from larger, national mall tenants makes them more stable. He noted that it takes almost two years of slowing sales before malls start to face falling rents and increased vacancies.

Peter Korpacz, MAI supports this view. He says that regional malls are protected by leases that span recessionary times and by credit tenants whose long-term strategies involve continued mall presence. These top-tier malls will either continue to maintain their values or at worst will suffer minimal, short-term value declines. He also likes grocery-anchored retail centers during tougher economic times. He reasons that consumers typically cut back on durable goods, such as furniture and electronics and reduce their expenditures on soft goods, such as apparel resulting in negative growth in those retail property categories. However, their overall tendency is to continue core buying habits even in a recession. People tend to increase spending on food and drink and other local services typically found in grocery-anchored food centers which support occupancy, lease rates and, ultimately, value.

So who should an investor listen to among the market experts? Obviously, many other factors than the national economy factor into specific property values. Property specific lease and vacancy rates and terms, local economic and political conditions, competition and, of course, property location all are important. Opinions are going to vary as to risk factors that factor in. But property type should be an important consideration in light of economic forecasts that highlight the very real possibility of recession.