The following is a guest blog by Benjamin R. Sellers, MAI.
Market analysis sets the stage for the valuation of a property. If it’s not right, then the value of the property likely won’t be defensible.
Why market analysis is important
The market analysis section of most appraisal reports is often overlooked in terms of applicable data and analysis relating to the subject property and the market in which it competes. Too many appraisers take a “one size fits all” approach to this section.
Appraisers must recognize that the market is constantly changing, and that certain scenarios require a higher level of analysis to provide a credible report for the intended user. There is no fixed formula, and certain relevant criteria must be addressed in complex assignments.
Market analysis and the valuation approaches
Market analysis conclusions are vital in supporting highest and best use and valuation analysis. The six-step process outlined in the Appraisal Institute-published book “Market Analysis for Real Estate,” second edition, by Stephen F. Fanning, MAI, AI-GRS, introduces a systematic approach that helps appraisers address relevant areas impacting the subject property.
The property’s desirability is based on several key factors and forms its productive capabilities to adequately serve the current market. These subject attributes, along with analysis of likely end user characteristics, needs and location, lends support to the appropriate selection and adjustments of comparables.
The interaction of demand and supply determines where we are in the current real estate cycle. Within highest and best use, market analysis conclusions provide support for the timing of development as vacant, and identification of the ideal improvement. As improved, functional issues are identified by comparison with market standard properties and, if found measurable, they are applied as obsolescence within the cost approach. Additionally, future reserves for functional obsolescence may need to be accounted for within the income approach.
Real estate markets move in cycles, and the market’s point within this cycle may impact property values. Market condition conclusions provide support for future anticipated changes in rents and occupancy levels within the overall market, forming the competitive landscape. This – together with determining how effectively the subject meets market desires compared to existing competition – offers greater support for a sound forecast of subject rent and occupancy in the income approach.
During recessions, occupancies decline. While variable expenses also may fluctuate with occupancy, the bulk of the expenses may be fixed, resulting in decreased net income and higher operating expense ratios during this time. Appraisers should consider these metrics when forecasting operating expenses at different points in time within the market cycle.
In her Feb. 14 comments to Congress, Federal Reserve Chair Janet Yellen cited CRE valuations as a growing area of concern as property prices continue to climb with capitalization rates compressed to historically low levels. Appraisals based only on the asset market may miss the underlying current fundamental value.
The Appraisal Institute’s Guide Note 10 offers another potential solution for going beyond point in time values by determining value sustainability over time for certain intended uses. This is an area where appraisers can provide expertise by communicating the durability of the value opinion over time, which can be done with sound market analysis.
Appraisers are charged with solving clients’ problems. In circumstances where markets are in flux, or when a property suffers significant obsolescence, the six-step process to market analysis provides a systematic approach to solving these problems in a credible manner. In addition, a thorough knowledge of the market analysis process can lead to opportunities outside traditional appraisal services, such as stand-alone market analysis studies or value sustainability opinions.
Appraisers must be aware of the crucial conclusions that play a larger role within the appraisal process and rethink how market analysis applies in their daily reports.
Benjamin R. Sellers, MAI, is an associate appraiser with Sellers & Associates, a real estate valuation and advisory firm in Clinton, Tennessee. Along with Stephen F. Fanning, MAI, AI-GRS, and Kerry M. Jorgensen, MAI, Sellers gave the presentation “Market Analysis: Application into the Overall Appraisal Parts” at the 2016 Appraisal Institute Annual Conference. Follow Ben on Twitter: @benrsellers.