Multifamily Devaluation (When Pigs Fly)

by John Wilhoit Jr. on

Pigs don’t fly and functional multifamily assets seldom trade at a significant discount to replacement costs.  Soon after TARP (Troubled Asset Recovery Program) was implemented in 2008 the sharks circled eying bundles of multifamily assets presumed to hit the market at distressed prices… fire sale prices. The sale never happened.  Why? ‘Because pigs don’t fly. 

Why is it so hard to devalue multifamily assets?  One reason is their popularity- the asset class has legs. Thus, even an upside down owner believes to their core that valuations will return “any minute” (note to self; market timing never works- see Gartman Interest Rate Observer) www.grantspub.com.  

In the fall of 2008 credit markets froze, we learned about TARP  and elected a new president.  As a HUGE problem is apt to do, TARP did little that connected with it’s name as few “troubled assets” were purchased with this government program. But we are  still here, minus a depression, so there were some significant positives to the intervention.

It is common for multifamily assets to trade at 80% of “replacement value”.  Appraisals are a necessary part of our business.  A third-party valuation is intended to provide an un-biased “opinion of value”.  We rely on these opinions to trade and finance assets. Appraisal’s often provide a cross section of valuation methods; market value and cost approach (sometimes referred to as replacement value).

Replacement Value: The value of an asset as determined by the estimated cost of replacing it.

Whereas we desire to determine value on multifamily assets based exclusively on their ability to earn “X” dollars, replacement value often times gets in the way. That uneasy feeling that surely this asset should have a higher valuation based on the cost to replace it.

As much as real estate asset prices are directly connected to revenue and NOI, replacement value is an underlying support to price and perceived value.  Is it the only one?  Of course not, but it acts as a constant reminder that requires buyers and sellers to think beyond just income and  expenses.

Land has value, structures have value. Replacement value refers to the cost of replacing buildings (or structures). We rightfully assume the costs of “new” construction is greater than the cost of original construction. Wood, drywall, roofing, fixtures, cabinets, labor, overhead, insurance.  In current dollars, all of these components of construction cost more today than they did yesterday (or one year ago, or ten years ago). 

Property values last peaked in 2007. The recession started prior to the collapse of Lehman in the Fall of 2008.  In that window (spring 2007 to summer 2008) cap rates were compressed, mortgage money flowed and multifamily transaction volume was at record levels. We are only now beginning to see some price appreciation.

Waiting around for multifamily prices to drop to some level far below replacement value is, in essence, a big waste of time. Companies large and small waited for this event with intentions of scooping up assets for pennies on the dollar.  It never happened.

From 2009 forward thousands of multifamily mortgages were in technical default, but the banks had bigger problems to address- things like assuring their very survival.  The possibility of foreclosing en mass on thousands of commercial assets was more than a daunting thought; it was impractical. The prospect of  collecting “bad assets” for resale in an era of such instability was beyond  the bounds of reasonable thought.

To find the answer to the question as to when multifamily assets prices will drop through the floor… see the title of this article.

About This Blog
Multifamily Insight is dedicated to assisting current and future multifamily property owners, operators and investors in executing specific tasks that allow multifamily assets to operate at their highest level of efficiency. We discuss real world issues in multifamily property management and acquisitions. This blog is intended to be informational only and does not provide legal, financial or accounting advice. Seek professional counsel.  http://www.MultifamilyInsight.com

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