The following Q&A was completed as part of our conversational Commercial Real Estate FAQ Interview Series, we hope you find it helpful.
Taking a conservative approach to valuing your commercial real estate assets will allow you to better under promise and overdeliver. It’s always better to find more value than less value, so assuming appreciation can mean playing a potentially disappointing game. Understand your asset, your risk, your parameters, and don’t be afraid to strip back all layers of a property while looking at each layer honestly and conservatively.
Richard Wilson: What are some unique methods or strategies that you have for valuing commercial real estate assets?
Ben Marks: We take a very, I don’t want to say it’s pessimistic, but we take a very very conservative perspective. I’ll tell you, a lot of the consulting work we do because we do look, I probably look at a hundred deals a week now, we really strip back all of the layers of the onion. We really dig into the assumptions. Again, I’m going to pepper you with some other quotes. Another of my favorite quotes, I think it’s from Mark Twain I’m not sure, it goes something like “It’s not what you don’t know that gets you in trouble. It’s what you think you know, it ain’t so.” And so assumption is the mother of all screw-ups, and so we really take a hard look at our assumptions and then peel back a lot of the noise. And there’s always noise on any given deal. Again, another anecdotal example, I’ve looked at projects and offer memorandums where the IRR on a stabilized tier 1, 100 unit multi family was 22%. And I can tell you these things don’t quintuple, or they don’t double every 5 years as a matter of general course, right? So, again, unless there’s something spectacular, development in play, or something in terms of risk of value add, those numbers are inflated and they can be inflated in a myriad number of ways which I won’t bore you with. But understanding your asset, understanding your risk and parameters.
Thirdly I’d add to that is we don’t have positive exit assumption. For example, if we underwrite it and we buy it at a 6 cap, we don’t assume we’re going to be able to sell it at a higher capitalization rate than what we bought it at. And what that does is it forces us when we go look at the rest of the numbers, whether there’s ROI or IRR, when you have an exit cap that’s equal to or less than your insurance cap it really forces you to look at the cash flows of the property exclusively. Which is why, to answer your question, the last portion of what we do in diligence that may differ is we don’t ever assume appreciation. We tend to get it a lot, thankfully, but we need to make sure the investments can sort of stand on their own purely based on a cash flow return, a cash or cash on cash basis, with no appreciation or impression of interest rates and what we find is we usually under promise and overdeliver. We’re very comfortable with that methodology.
