2. One Step Further Practical Implementation of Guide Note 12

3. Equilibrium - The theoretical balance where demand and supply for a property, good or service are equal. Over the long run, most markets move toward equilibrium, but a balance is seldom achieved for any period of time. The Problem

4. Real estate markets characterized by cycles (gradual or boom-and-bust) An appraisal can quickly become outdated The Problem

5. The Appraiser’s Role: The appraiser’s perspective The client’s perspective Point of Agreement: Value at a single point in time may not be adequate for some intended uses The Problem

6. Two risks in use of an appraisal: – Value opinion is unreliable due to lack of quality data (or analysis) – Value might not be sustainable over time The Solution – Guide Note 12

7. Factors of change vs. symptoms of change Capital markets and fundamental markets each cause markets to change Market analysis (6 steps) allows the appraisal to be forward looking Unforeseen events can invalidate conclusions of market analysis The Solution – Guide Note 12

8. As appropriate, reconciliation should discuss the likelihood the value might not be sustainable into the foreseeable future The Solution – Guide Note 12

9. Predictions are not meaningful Risk of a lawsuit Clients will not like it More work with no additional compensation Concerns about Guide Note 12

10. Real Estate Market Cycles

11. Capital markets – Equity capital (investors) – Debt capital (lenders) Fundamental markets – Space users Real Estate Market Cycles

12. Entrepreneurial Incentive – Minimum necessary to justify construction – Not potential profit at a given point in time – Concept of positive external obsolescence – Challenges to application Tools for Analyzing Cycles

13. Frictional Vacancy – vacancy unrelated to disequilibria in supply and demand… a typical vacancy rate in a given market operating in equilibrium. Tools for Analyzing Cycles

14. Feasibility Rent – the rent necessary to justify new construction. When the market is at equilibrium, the rental rate for new, fully functional space is equal to feasibility rent. Tools for Analyzing Cycles

15. Feasibility Rent Example Replacement cost new (per square foot or per unit) for fully functional space, including land and entrepreneurial incentive $100.00 Multiply by the overall capitalization rate x 0.085 Feasibility net operating income per square foot or per unit $8.50 Add fixed expenses per square foot or per unit + $1.50 Subtotal $10.00 Divide by (1 – variable expense ratio) ÷ 0.80 Feasibility effective gross income per square foot or per unit $12.50 Divide by (1 – frictional vacancy) ÷ 0.92 Feasibility rent per square foot or per unit $13.59 Tools for Analyzing Cycles

16. Equilibrium Rent – what market rent should be for a subject property, assuming the market is at equilibrium (hypothetical) Tools for Analyzing Cycles

17. Subject Equilibrium Rent Example Subject replacement cost new (10,000 SF @ $70)$700,000 Entrepreneurial incentive (Minimum necessary to justify new construction when the market is at equilibrium) $70,000 Depreciation (excluding external obsolescence due to market conditions)($170,000) Subject depreciated improvements cost$600,000 Land value$200,000 Subject depreciated replacement cost including land$800,000 Multiply by the overall capitalization ratex 0.0875 Subject equilibrium net operating income$70,000 Add fixed expenses+ $17,000 Subtotal$77,000 Divide by (1 – variable expense ratio)÷ 0.80 Subject equilibrium effective gross income$96,250 Divide by (1 – vacancy rate estimate for subject when the market is at equilibrium)÷ 0.90 Subject equilibrium potential gross income$106,944 Divide by rentable SF or units÷ 10,000 SF Subject equilibrium rent estimate$10.69/SF

18. Affordability Analysis Affordability Index – a measure that indicates potential buyers’ ability to purchase a home Tools for Analyzing Cycles

19. Residential Affordability Analysis (Owner Occupied) Affordability Loan Terms Down payment ratio (at sustainable ratio)10% Mortgage interest rate (at sustainable rate)5.00% Mortgage term in years30 Ratio of income available for mortgage payments (at sustainable ratio)25% Analysis of Affordable Median Home Price Median household income in competitive market$67,750 Ratio available for mortgage payments25% Annual income available for mortgage payments$16,937.50 ÷ 12 months Monthly income available for mortgage payments$1,411.46 Monthly loan constant (by financial calculator or spreadsheet)÷ 0.0053682 Affordable mortgage amount$262,929 Mortgage ratio (loan-to-value ratio)÷ 0.90 Affordable median home price$292,143 Actual current median home price$312,000 Affordability index (affordable ÷ actual current)0.936

20. Residential Affordability Analysis (Renter Occupied) Affordability Rent Limit Ratio of income available for rent (at sustainable ratio)25% Analysis of Affordable Median Home Price Median household income in competitive market$52,500 Ratio available for rent25% Annual income available for rent$13,125.00 ÷ 12 months Affordable median rent$1,094 Actual current median rent$1,025 Affordability index (affordable ÷ actual current)1.067

21. Tools for Analyzing Cycles

22. Retail Affordability Analysis Gross rent indicated by comparables$30.00 Affordability rent ratio for subject type space7.0% Indicated square foot sales required$428.57 National median sales per square foot$300.00 Percentage over national median sales43% Tools for Analyzing Cycles

23. Retail Affordability Rent Estimate Current or forecasted subject sales per square foot$250.00 Affordability rent ratio for subject type space7.0% Indicated affordability rent for subject$17.50 Tools for Analyzing Cycles

24. Market Area for Class A Apartments Year Rental Rate per Square Foot (Current Dollars)% Increase 4 years ago$0.80-- 3 years ago$0.856.3% 2 years ago$0.905.9% 1 year ago$0.955.5% Current$0.983.2% Tools for Analyzing Cycles

25. Market Analysis (6 step process) – Property productivity analysis – Market delineation – Demand analysis – Supply analysis – Marginal demand analysis (comparison of supply & demand) – Projection/forecast of subject capture Tools for Analyzing Cycles

26. Fundamental Analysis of Supply and Demand Current Forecast +5 Years Forecast +10 Years Current and forecasted demand (occupied sq. ft.) 1,377,0001,593,0001,791,000 Adjustment for frictional vacancy (10%)÷ 0.90 Supportable space (sq. ft.)1,530,0001,770,0001,990,000 Current supply (sq. ft.)1,800,000 Net new construction*--- Forecasted supply (sq. ft.)1,800,000 Marginal demand – (excess)/shortage of supply (270,000)(30,000)190,000 Current and forecasted occupancy rate (demand ÷ supply) 76.5%88.5%-* * New competition is left at "0" for the initial look at the market, and then adjusted in the next study phase, if warranted. Tools for Analyzing Cycles

27. Market Rent (For New Const) Market Vacancy Construction Volume Development Profit Expansion Above feasibility rent and increasing Below frictional vacancy and decreasing Less than growth in demand Above entrepreneurial incentive Contraction Above feasibility rent, but flat or decreasing Below frictional vacancy, but increasing More than growth in demand Above entrepreneurial incentive Recession Below feasibility rent and flat or decreasing Above frictional vacancy and increasing More than growth in demand Below entrepreneurial incentive RecoveryBelow feasibility rent and flat to increasing Above frictional vacancy, but decreasing Less than growth in demand Below entrepreneurial incentive Determining Current Market Stage

28. Reporting Conclusions Midvale Office Market Expansion Recession Contraction Recovery Equilibrium Midvale Office Market

29. Reporting Conclusions ExpansionContractionRecessionRecovery

30. Equity market – Capitalization rates and yield rates – R = Y - CR Debt Market – Interest rate and terms – Underwriting criteria (LTV, – Marginal demand analysis (comparison of supply & demand – Projection/forecast of subject capture Analyzing Capital Markets

31. One step further called for by Guide Note 12 means: Appraisal becomes more valuable tool Future of appraisal profession is brighter Conclusions