Financially Distressed Asset Valuation and Pricing

1. Financially Distressed Asset Valuation and Pricing Thomas O. Jackson, Ph.D., AICP, MAI, CRE, FRICS Texas A&M University and Real Property Analytics, Inc. 979-690-1755 tjackson@mays.tamu.edu tomjackson@real-analytics.com

2. Concepts • Market value • The most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently, knowledgably, and assuming the price is not affected by undue stimulus. • Source: Office of the Comptroller of the Currency

3. Concepts • “As is” market value • The price at which a third-party purchaser could acquire the property in its “as is” condition and then cover all the remaining costs associated with completing construction, sellout, or lease up and earn a market-based level of profit for doing so. • Acknowledges that entrepreneurs demand compensation for purchasing distressed real estate. • Source: Appraisal Institute, Appraising Distressed Commercial Real Estate

4. Concepts • Liquidation value • The most probable price which a specified interest in real property is likely to bring under all of the following conditions: • Consummation of a sale will occur within a severely limited future marketing time specified by the client. • Actual market conditions are those currently obtained for the property interest appraised. • Source: Dictionary of Real Estate Appraisal, 4th Edition

5. Concepts • Liquidation value (continued) • The buyer is acting prudently, knowledgably, and is typically motivated • The seller is under extreme compulsion to sell • The buyer is acting in what he or she considers his or her best interests • A limited marketing effort and time will be allowed for the completion of the sale • Payment will be made in cash in U.S. Dollars or in terms of financial arrangements comparable thereto

6. Concepts • Disposition value • The most probable price that a specified interest in real property is likely to bring under all of the following conditions: • Consummation of a sale will occur within a limited future marketing period specified by the client • The actual market conditions currently prevailing are those to which the appraised property is subject • The buyer and seller are each acting prudently and knowledgably • The seller is under compulsion to sell. • The buyer is typically motivated

7. Concepts • Disposition value (continued) • Both parties are acting in what they consider their best interests. • An adequate marketing effort will be made in the limited time allowed for the completion of the sale. • Payment will be made in U.S. dollars or in terms or financial arrangements comparable thereto. • The price represents the normal consideration for the property sold, unaffected by special or creative financing or sales concessions granted by anyone associated with the sale. • Source: Dictionary of Real Estate Appraisal, 4th Edition

8. Concepts • Distressed real estate • In general, distressed real estate represents those properties suffering from higher than typical vacancies • Properties where effective rents of prices have declined significantly in order to attain lease up or sale • Source: Appraisal Institute, Appraising Distressed Commercial Real Estate

9. Concepts • Net realizable value SP = Pr (X<=1) x MV NRV = SP – (C – R) / (1+ r)n SP = selling price MV = market value Pr (X>=1) = probability of one or more offers in holding period C = carrying costs R = effective gross income r = market discount rate

10. Valuation Issues • As is market value • High vacancies • Lower net income • Below market rents • As though stable • Assumes stabilized occupancy • Assumes market rents • Current date of value (hypothetical condition) • When stabilized • Market analysis to determine future date when stabilization may occur (extraordinary assumption) • Future date of value

11. Valuation Issues • Lease up adjustment • Difference between current (as is) occupancy and rents and stabilized occupancy • Projection of rent loss until stabilization • Difference between hypothetical as if stable and as is scenarios until stabilization is reached • Present value of rent loss • Adjustment to current as if stable value • Adjustment to sale and cost approach estimates

12. Valuation Issues • Income capitalization approach • Yield capitalization (DCF analysis) • Estimating buyer’s or market segment’s yield can be complex • Few or no transactions • Little market activity • Constrained capital markets

13. Valuation Issues • Market simulation • Simulated transactions • More emphasis is placed on how people make decisions rather than what they decided because no transactions have transpired in the current market • DCF analysis given its explicit input format might be most appropriate model to simulate buyer behavior • Source: T. Grissom, Appraising without Comparables, 1988, Texas A&M Real Estate Center)

14. Valuation Issues • Yield and income capitalization rates • Income capitalization rates composed of the yield rate yield rate and expectations of property value and income growth • Property models RO = YO - A RO = YO - ΔO a RO = YO - ΔOSFF RO = YO - ΔO1/n RO = YO - CR

15. Valuation Issues • Built up or blended rates RO = ( E x RE ) + (M x RM) RE = (RO - (M x RM)) / E • Ellwood RO = (YE – M(YE + P 1/SFF – RM) Δo 1/SFF) / (1 + Δi J or K) • Ellwood in Akerson Format Weighted average of mortgage and equity requirements adjusted for equity buildup due to loan paydown and appreciation

16. Valuation Issues • Final thoughts • Is this a dilemma in which the value cannot be estimated without knowing the capital structure and the capital structure cannot be known without knowing the value?