Andrews: What comes around, goes around
I've just returned from 10 days in the Northwest, visiting clients and family living in the Portland area. And in addition to having the rare opportunity to stand in snow on Mt. Hood, the trip gave me a firsthand look at just how tight a rental market can get. According to the local paper, Portland's apartment vacancy rate fell to 2.2% in June, which makes it the second-tightest rental market in the country. Meeting with clients there, we talked about the feasibility of purchasing apartments—or infeasibility of it, rather. At time when owners are enjoying significant cash flow, following years of slim pickings, it's causing expectations of sale prices and cap rates to get a bit out of whack. The problem is that underwriters and appraisers won't use a 97.8% average occupancy when valuing a property, and instead are applying a generic 92% to 93% when running the loan sizing. It's a similar situation to what happened in our rental market after hurricanes Katrina and Rita, when there weren't vacant units to be found anywhere. But, as we know, just because occupancy was high at one point in time doesn't mean we're able to continue using those figures for loan underwriting or valuation purposes indefinitely. That's because those occupancy levels didn't last, settling to between 92% and 93% at present in Baton Rouge. As local appraiser Craig Davenport tells me: "Appraisers have to use what they believe to be sustainable operating levels when valuing properties," adding, "Just because a property has been running at 98% occupancy for six months does not mean that it would be prudent to use that level when valuing a long term asset." The key here is determining what the market and the investment can sustain over the long haul, as well as what the operating expenses will be year in and year out. And it highlights that proper underwriting of any deal may start with a look at the recent project numbers but must be grounded in long-term perspective, which may be provide a vastly different view.
(Brian Andrews is a certified mortgage banker specializing in the financing of commercial real estate. His business is Andrews Commercial Real Estate Services, and he can be reached at email@example.com.)
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