We left off in the last entry talking about different types of property conditions that lend themselves to the “Forcing Appreciation” strategy.
Undervalued property is typically made up of properties that have fallen out of investor favor. These types of properties tend to fall into this category on a cyclical basis due to changes in the capital and investment markets. They become undervalued often times due to the lack of availability of favorable financing terms. In today’s market an example of under valued properties would be condominiums or condominium conversions, specifically in the areas of South Florida, Las Vegas, or the Carolinas where many developers were counting on a lot of movement from second home buyers. Mislead initially brisk sales, aggressive developers and lenders contributed to overbuilding in these markets.
This happened because the sales of units where largely to investors looking to profit by reselling, not from the actual end user. As a result many of the investors find themselves in the very undesirable position of facing the choices of continuing to watch rapidly declining values while waiting for a market recovery that is not coming any time soon, selling at a loss to stop the bleeding, having the lender call the loan, owning unfinished units or worst of all owning within projects that have never broken ground and likely never will.
We will profit by being there to pick up the pieces when the lenders come to terms with their poor investment decisions and realize that the must take the loss and get on with the business of lending money, not managing properties or developments. We can also profit when the investor gets tired of the red ink, and gives up on the property or at least on the idea that they have any true equity in the project.
There are many other under valued market segments beside the example sited above. Under valuing is not simply a property type issue either. It could be based on geographic concerns, physical composition or usage limitations, or many other factors, but those are for another discussion
This type of investment gains its value added elements by having an inferior use. We are talking about the principle of “highest and best use”. Highest and best use is a concept very common in the commercial real estate world. Highest and best use attempts to evaluate which type structure would serve the current market needs the best. An example of this could be demonstrated by looking at the history of a piece of raw undeveloped land.
Let’s establish that a particular parcel was used for agriculture in early 1900′s, as time moved forward by the 1960′s the parcel became desirable by the local municipal government for the construction of a roadway project. This caused a subdivision of the property. Upon subdividing the parcel, a corner location became ideal for a grocery market and shops for merchants. As moving forward as we moved to present day, the shops become less valuable because many super stores and category killers such as Lowes or Home Depot have moved into the area chasing the shop keepers out of business and the local grocer folded under competition of the super market that offered a wider variety, and better pricing due to greater volume of merchandise sales.
Today a new developer is looking to put a gas station, convenience mart, and car wash on this well traveled corner currently occupied mostly vacant shops with to little selection and inadequate parking. The developer is attempting to capitalize on the change of use to meet the demands of the current market area.
Under performing properties are traditionally suffering from significant vacancy. When a property is experiencing substantial vacancy, its value declines because it is not generating the income necessary to reach its market potential. The reasons for the vacancy can vary widely.
Some of the many reasons will be correctable, such as inappropriate rental rates or unfavorable leases for the marketplace, while others will not be easily corrected for example, an inferior location, or an obsolete building layout just to name a few. A proper evaluation of the factors contributing to the lack of performance is essential before moving forward with an investment decision. This type of opportunity gains its potential in direct relation to our ability and skills in restoring performance to the occupancy and rent roll. (To be Continued…)