From US Capital Trends November '08
Determining the market value of a property in the current environment is a challenge. Such low levels of volume result in few data points for comparison and leave market averages vulnerable to being skewed by one or two deals.
For example, in the office sector average prices are near record highs and average cap rates have actually fallen in recent months. While the statistics are accurate, they are clearly not reflective of the market, where the opposite is occurring. In this example and across other property types, such results reflect a mix of more expensive properties that are currently trading due to the flight-to-quality assets sought by active buyers. A greater proportion of deals have occurred in the top markets and far fewer sales have materialized in secondary and tertiary markets. Investors are seeking top quality properties with secure tenancies and are avoiding the value-added opportunities that comprised so much of the activity prior to the credit crunch.
It is not just the mix of assets that have changed, but also other metrics as well. Some argue that cap rates today are more “real” than previously, when speculative income and healthy rent growth assumptions were commonly used to make investment calculations and decisions. Today, NOI is far more conservatively underwritten, using in-place income that is further reduced by credit loss expectations. Because cap rates are calculated more conservatively, increases in the market averages underestimate the true increase.
Establishing pricing is further complicated by the considerable growth in transactions involving assumable debt and, increasingly, seller financing. In either situation, mortgage terms are likely to be better than market rates and the benefit of this financing can inflate the sales price.
Until the marketplace becomes more liquid and efficient, cap rates and other market averages should be reviewed with some skepticism.