capitalization rate analysis - the Shelby County Assessor of Property

Transcription

LANDAMERICA VALUATION CORPORATION
Brookside Concourse
4300 Alexander Drive, Suite 200
Alpharetta, GA 30022
Phone 800-207-7959
Fax 770-777-6136
www.landam.com
CAPITALIZATION RATE ANALYSIS
OF
COMMERCIAL PROPERTIES LOCATED IN
SHELBY COUNTY, TENNESSEE
DATE ISSUED: FEBRUARY 19, 2009
LVC PROJECT NUMBER: 08-13954.1
PREPARED FOR
MS. CHEYENNE JOHNSON
SHELBY COUNTY ASSESSOR
160 NORTH MAIN STREET
ROOM 550
MEMPHIS, TENNESSEE 38103
PREPARED BY
LUTEN L. TEATE, MAI
JOHN W. CHERRY, JR., MAI, CRE
KAREN BURKHART DICK, CRE, CCIM
FOR QUESTIONS OR MORE INFORMATION ABOUT THIS REPORT,
PLEASE CONTACT YOUR LVC NATIONAL CLIENT MANAGER,
JOHN W. CHERRY, JR. AT (770) 777-6124.
TABLE OF CONTENTS
Introduction ........................................................................................................................ 1
Capitalization Rates ............................................................................................................ 8
Memphis Economic Overview ......................................................................................... 16
Office Properties............................................................................................................... 20
Industrial Properties.......................................................................................................... 27
Retail Properties ............................................................................................................... 32
Hotel/Motel (Lodging) Properties .................................................................................... 40
Multi-Family Properties.................................................................................................... 46
Golf Courses ..................................................................................................................... 51
Assisted Living Facilities ................................................................................................. 53
Mobile Home Parks (MHPs) ............................................................................................ 56
Summary and Observations.............................................................................................. 57
Addendum ........................................................................................................................ 57
LVC Project No. 08-13954.1
Shelby County Government
INTRODUCTION
The Assessor of Property for Shelby County, Tennessee (the “County”) has retained
LandAmerica Valuation Corporation (“LVC”) to prepare a Capitalization Rate Analysis. The
County is required by state law to reappraise approximately 10,000 to 15,000 properties by the
income approach for ad valorem tax purposes for Year 2009. This report will assist the County
in selecting appropriate overall capitalization rates for five core property types: office, industrial
(warehouse and light industrial), retail, hotels, and multi-family properties (apartments). Net
lease properties and assisted living facilities are also included in this analysis due to the recent
popularity of these properties among investors.
The effective date of our market research occurred from June through October 2008. However,
we have provided the 4th Quarter 2008 Investor surveys. Property transactions were
predominately utilized from years 2007 through year to date 2008. A few sales were used from
the fourth quarter of 2006, however. This report provides a written summary of our findings,
organized under the following headings:
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Capitalization Rates
Memphis Economic Overview
Office Properties
Industrial Properties
Retail Properties/ Net Lease Properties
Hotel Properties
Multi-Family Properties
Assisted Living Facilities
Golf Course (Limited analysis)
Mobile Home Parks (Limited analysis)
These sections are preceded by an explanation of terms used in the report, and a description of
our scope and methodology. Conversely, the report is followed by an Addendum comprised of
three sections:
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Addendum I – Certification
Addendum II – Standard Conditions
Addendum III – Qualifications
The market data that an appraiser relies on is always dated but this factor is especially important
in a volatile market environment like we are facing today. We have seen a decline in sales
activity across all sectors of the real estate market over the last year. Further, overall
capitalization rates across all segments of the market have increased. However, with only limited
recent sales activity to rely on we have to consider many different data sources to aid in our
concluded rates. One of the more important sources is our interviews of local brokers. We rely
heavily on the consensus of opinions of these local brokers about the current market conditions
and achievable overall capitalization rates.
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DEFINITIONS
A clear definition of certain terminology is necessary for an understanding of the analysis and
results of this study. Thus, the following terms, which are critical to determination of
capitalization rates, are defined and explained.
• Capitalization – The conversion of income into value.
• Capitalization Rate – Any rate used to convert income into value.
• Cash Equivalency – The procedure in which the sale prices of comparable properties sold
with atypical financing are adjusted to reflect typical market terms.
• Institutional-Grade Real Estate – Real property investments that are sought out by
institutional buyers and have the capacity to meet generally prevalent institutional
investment criteria.
• Overall Capitalization Rate (cap rate) – An income rate for a total real property interest
that reflects the relationship between a single year’s net operating income expectancy and
the total property price or value; used to convert net operating income into an indication
of overall property value
• Net Operating Income (NOI) – The actual or anticipated net income that remains after all
operating expenses are deducted from effective gross income, but before mortgage debt
service and book depreciation are deducted; may be calculated before or after deducting
replacement reserves. NOI is also prior to deducting leasing commissions and tenant
improvements.
• Replacement Allowance (Reserves) – An allowance that provides for the periodic
replacement of building components that wear out more rapidly than the building itself
and must be replaced during the building’s economic life. We have found that in most
Southeastern markets, including Memphis, reserve allowances are not typically included
as an operating expense by buyers, sellers, or brokers for most property types. The
exceptions are apartments, assisted living, & lodging properties.
As these terms apply directly to this study, Overall Capitalization Rate (“cap rate”) and Net
Operating Income (NOI) are the most critical to our analysis. When referring to “cap rate” and
“NOI” within this report we are implying that the NOI reflects a property’s income potential at
normal or stabilized operating levels regarding rent, vacancy, and expenses. That is, the property
is at or near stabilization. Consideration is also given to the point in time of the NOI estimate.
That is, the NOI based on actual, preceding year, current, or budgeted estimates. In estimating
cap rates, consistency in the analysis of the transactions is essential. This involves the other
definitions including Reserves and Cash Equivalency. In verifying sales and extracting cap
rates, we were certain to apply consistent analysis to the sales regarding financing and reserves.
The primary data source for improved sales leads in this study was CoStar and LoopNet, both
on-line real estate reporting services. These leads were further researched and verified with
reliable sources. Also, the commercial appraisers employed by Shelby County were interviewed
regarding their personal knowledge of transactions and information in their databases. Improved
property sales from late 2006, 2007 and 2008 were considered as well as current negotiations for
properties under contract. Also, interviews were conducted with investment companies active in
the Shelby County market and investors in other southeastern locations familiar with and/or with
assets in the Shelby County area. The quality and amount of data available for transactions varies
greatly depending on the confidentiality of the information and willingness of the parties
involved to release the information.
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We also used CoStar as the primary source for data about inventory, absorption, vacancy,
deliveries, under construction inventory, and quoted rental rates for each property type in our
study. It is important to note that CoStar is just one of the data sources for this type of data, and
for the most part, the various data sources are not consistent because they use different sampling
techniques. We chose to rely on CoStar because it is a national data source and has historical
depth.
SCOPE AND METHODOLOGY
The scope of services for this engagement encompassed the following methodology:
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Meeting with the Appraisal Staff of the Shelby County Assessor’s Office to discuss the
study, review the process and approach.
Review the available data and information accessible in the County Assessor’s office and
other sources of transactional data.
Interview appraisers for a historical perspective on the process and develop a best
practices approach to the study.
Determine a reasonable sample size of improved sales to accomplish the study for each
property type concerned.
Determine the most acceptable approach to developing net operating incomes for the
various property types regarding reserves and vacancy. However, as requested by the
client, we presented overall capitalization rates with and without reserves for several
property types.
Discuss which approaches and techniques are most acceptable and should be employed to
support the capitalization rates such as transactions, investor interviews and surveys such
as the Korpacz Real Estate Investor Survey Fourth Quarter 2008 and RealtyRates.com.
Develop a matrix of capitalization rates appropriate for the building classes and subcategories and,
Review our conclusions with the County and submit our report.
Additionally, we have prepared an economic overview of Memphis/Shelby County to better
understand the nature of the economic base, demographic trends, and the area’s future outlook.
Finally, a brief market overview of the current status of each of the five basic property types is
presented for better understanding of the current position of these properties in the real estate
cycle.
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RESERVE ALLOWANCE ASSUMPTIONS
As mentioned earlier, we have found that in most Southeastern markets, including Memphis,
reserve allowances are not typically included as an operating expense by buyers, sellers, or
brokers for most property types. The exceptions are: apartment, assisted living, and lodging
properties. However, at your request, we have presented our overall capitalization rate
conclusions for most property types both with and without reserves for replacement reserves as
an operating expense item. The following chart depicts typical reserve allowances as taken from
the 4th Quarter 2008 RealtyRates.com investor survey. This survey data was used in estimating
the reserve allowance for each property type.
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Based on the above data, we selected reserve allowances to use in our analysis. These selections
are by property type and class of property. Our selections are summarized below.
Reserve Allowances By Property Type and Class
Industrial
$/S.F. or $/Unit
Class A Class B Class C Class D
$0.20
$0.25
$0.35
$0.50
Retail
$0.25
$0.30
$0.45
$0.70
Office
$0.25
$0.30
$0.45
$0.60
Apartments
$150
$250
$335
$375
Assisted Living
$260
$300
$385
$650
MARKET CONDITIONS
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In the year since the subprime mortgage crisis and the beginning of the “national credit
crunch”, the availability of funds for debt on real estate investments has almost
disappeared and the national economy has weakened with no signs of recovery. As a
result, most sectors of the real estate market have suffered in some capacity.
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We have seen a decline in sales activity across all sectors of the real estate market over
the last year. There are several reasons for this phenomenon, the most notable: The lack
of available debt funds, fewer buyers, uncertain pricing, and the more conservative
underwriting requirements by lenders that remain active.
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The lack of debt funds and the more conservative underwriting criteria has severely
limited the number of consummated transactions.
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Many sellers have pulled out of the market and many of those that remain are highly
motivated to sell so are willing to liquidate at prices they would not accept a year ago.
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Leasing activity is down in all sectors of the real estate market over the last year.
Investors appear nervous about the future of the economy, future tenant demand, and
space needs.
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The failure of prominent Wall Street firms and national banks has lead to further
uncertainty in the market and a decrease in consumer and investor confidence. This has
lead to the limited availability of debt.
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Comments from a lender survey in October 2008 reflect the following telling responses:
¾ “we are out of the market”; “we are on hold”; “not quoting for the balance of
2008”; “waiting on new internal guidelines”.
¾ “we are quoting very selectively”; “only construction with existing clients on a
limited basis”; “only lending on credit and owner occupied deals”.
¾ “treasuries plus 250 to 300 basis points plus a ¼ point”; “a 1.20X DSC and max
leverage out at 75% LTV”; “65% LTV or less, spreads at 315bp’s. Long money
available”; “Can do up to 70%”; “55% to 65% loan to value, major metro areas
only, all major property types”.
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In the final analysis, our research suggests that capitalization rates have increased over
the last year due to a number of real estate and general economic factors. Unfortunately,
they will probably continue to change between the writing and publication of this report.
Most knowledgeable sources do not expect the problems in the economy or real estate market to
improve for the near-term. Likewise, improvement in debt availability and lending practices is
not forecast for the near-term. All agree that the investment market is at a standstill due to the
credit crisis and deteriorating condition of the debt and capital markets. Very few properties are
trading, making it difficult to gauge where prices and cap rates are in today’s market.
EMERGING TRENDS IN REAL ESTATE
The Urban Land Institute and PricewaterhouseCoopers publish the annual Emerging Trends in
Real Estate and the publication for 2009 has the following comments. Unfortunately, this study
was prepared during the summer of 2008 and the volatility in the economy and real estate
markets make this study somewhat outdated today. However, we consider many of the points
still appropriate:
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“The credit crisis and the ensuing recession promise to drag the commercial real estate
markets into a difficult period marked by value losses, rising foreclosures, and reduced
property revenues.”
“Among property sectors, only apartments show some enduring strength-increasing
numbers of young adults and people pushed out of the market keep rent rolls relatively
healthy.”
“Expect financial and property markets to hit bottom in 2009 and flounder well into
2010…”
The following needs to happen for a recovery to ensue. “Private markets need to correct;
Debt capital needs to flow; Regulators need to help restore confidence in the securities
markets; the economy needs to improve; Housing’s condition (needs to improve)…
Forget the quick fix. “
And regarding capitalization rates, the following quote paints the upward trend.
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“An interviewee consensus calculates that cap rates need to increase about 150 to 200
basis points on average from their recent lows to more normal 7.5 to 8.5 percent territory
depending on the property sector, market, and asset quality. That translates into a possible
15 to 20 percent value haircut. Trophy, 24-hour city properties should have less
exposure-with their cap rates rising 50 to 75 basis points-while B and C product could see
increases of 200 to 300 points.”
On a property type basis the prospects for shifts in capitalization rate show increases from
July 2008 to December 2008 ranging from a low of 42 basis points for warehouse to a
high of 73 points for limited service hotel.
And the impact on values is not just the upward trend in cap rates but also the “double
whammy” of decreasing NOI streams due to increased vacancy rates, increased tenant
inducements, and pressure on rent levels.
MARKET DATA
We researched and assembled numerous sales of improved properties for this assignment. Only
those sales which could be verified by one of the participating parties, a third party such as a
broker or attorney, or from a reliable source, were utilized in our sales database. Many sales
were not concluded to represent arm’s length transactions due to a variety of reasons which
could include internal relationships between buyer and seller, deed-in-lieu of foreclosure
transaction, creative financing, quit claim deeds or transfers, condemnation proceedings, and
other legal transactions which may cause us to reject a sale. We realize that these types of
transactions are part of the broader market, especially in these market conditions. However, these
sales were not considered in our analysis and conclusions because they do not represent market
value transactions relative to the definitions provided in the Addenda of the report.
It is also important to note that sales of vacant buildings and in some cases owner occupied
buildings or opportunity or “turnaround sales” were concluded not be acceptable transactions
from which to generate and overall cap rate.
Finally, as we stated earlier, the market data that an appraiser relies on is always dated but this
factor is especially important in a market environment like we are facing today. We have seen a
decline in sales activity across all sectors of the real estate market over the last year. Further,
overall capitalization rates across all segments of the market have increased. However, with only
limited recent sales activity to rely on we have to consider many different data sources to aid in
our concluded rates. One of the more important sources is our interviews of local brokers. We
rely heavily on the consensus of opinions of these local brokers about the current market
conditions and achievable overall capitalization rates.
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CAPITALIZATION RATES
The purpose of this section is to define capitalization rates (“cap rates”) and their use in this
study. It is organized in five sub-sections:
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Derivation of capitalization rates
Capitalization rates selection criteria
Direct capitalization strengths and weaknesses
Property class transition
Capitalization rate spreads
DERIVATION OF CAPITALIZATION RATES
A cap rate reflects a relationship of a property’s single year of net operating income estimate as
compared to its sales price. Cap rates, thus, can vary based upon the NOI which is utilized in
this analysis. The NOI could reflect the actual historical NOI, the year to date annualized, or
next years budgeted NOI. Most market transactions are based on the next twelve month
budgeted NOI or current in-place NOI. This is another area of inconsistency which should be
followed and understood in developing cap rates.
Cap rates can be derived from abstraction from market sales, mathematical formulas, and
investor surveys. Emphasis in this study has been placed upon actual market transactions and
investor surveys-both personal interviews and published studies.
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Published Studies: Most surveys are performed on a national or regional basis. Of the
five surveys we considered, only Real Estate Research Corporation and Real Capital
Analytics addressed the Memphis area specifically. However, neither survey addressed
all the Memphis area property types that we are analyzing. Those surveys considered in
this report are the Korpacz Real Estate Investor Survey, RealtyRates.com, and Real
Estate Research Corporation. These surveys typically provide a fairly wide range of cap
rates applicable to certain property types and generally involve only investment or
institutional grade properties.
Each of the surveys cited in this study reflect what is commonly referred to as investment
grade property. This typically includes only class A and good class B level real estate.
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Personal Interviews: We conducted a telephone survey of eight real estate investors and
advisors during the week of October 13, 2008 to gain insight into the Memphis
investment market, focusing on cap rate trends. The respondents included professionals
in the areas of acquisitions/dispositions, asset management, investment sales, and
mortgage banking from the following firms: CBRE Capital Markets, CBRE/Melody,
Cushman & Wakefield, Holiday Fenoglio Fowler, Industrial Developments International,
Met Life, Northwestern Mutual, and Trimont Real Estate Advisors.
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All agree that the investment market is at a standstill due to the credit crisis and
deteriorating condition of the debt markets. Very few properties are trading, making
it difficult to gauge where prices and cap rates are in today’s market. Assets in
second-tier cities like Memphis are being adjusted by 50-100+ basis points above
national cap rates depending on the type of property; and institutional investors are
generally not favoring Memphis with the exception of industrial and retail properties.
Cap rates fell to an all-time low at the peak of the investment market in late
2006/early 2007. Since that time, cap rates have increased in all property sectors, a
trend that will continue until lenders are willing to finance properties at reasonable
terms and costs.
CAPITALIZATION RATES SELECTION CRITERIA
There are various economic and physical factors which impact the risk of a particular investment
and its implied capitalization rate. These criteria should be understood in the application of and
selection of cap rates. The Economic and Physical factors that impact risk are considered to be
as follows:
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Ownership position – This refers to the interest or the estate being transferred such as
fee simple, leased fee, or leasehold. These interests are created by leases, mortgages,
etc. and can impact the risk ascribed to an investment.
Management burden – This varies by property type and can influence expense ratios
and, thus, cap rates accruing to certain property types.
Use – The marketability of a property can be impacted by its use as with special
purpose properties versus general purpose properties.
Location – This, of course, is critical to the success of a real estate development and
involves factors such as demographics, transportation, exposure, and marketability.
Geographical/Political Forces – These factors can influence either positively or
negatively the willingness of investors to purchase or develop property in the area.
These issues could involve zoning, transportation issues, utility and infrastructure
issues, and real estate tax rates.
Financing – The availability and price of debt has a direct impact on new
development and property transactions. As mentioned, cap rates analyzed herein and
assume an unleveraged position or cash equivalent financing. However, the
availability of financing has an impact on the potential buyer’s ability to purchase a
property since most commercial real estate is purchased with financing. The recent
“credit crunch” has severely impacted the purchase activity in all types of real estate.
Current alternative yields – This consideration involves rates of return available in the
current marketplace from alternative investment vehicles such as mortgages, bonds,
and certificates of deposit.
Ease of entry into development of product type – Certain property types may take
years to conceive, approve and develop whereas others are easily processed though
the development cycle and thus, subject to overbuilding. This feature can restrict
supply and influence cap rates.
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Property Specific Criteria include the following:
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Operating expense ratio – Typically, a higher expense to gross income ratio, reflects a
higher capitalization rate.
Remaining economic life – Real property is a depreciating asset and as properties age
they experience class or quality transition, their remaining economic life shortens and
the capitalization rates generally increase.
Occupancy/Rollover Risk – Overall rates are typically analyzed on an “as if” or
stabilized basis. High vacancy rates or near term tenant expirations or rollover risk
can greatly influence the cap rate acceptable to a buyer.
Potential for growth in NOI – Growth in NOI can influence the current years overall
rate. This growth can come from market conditions, stepped base rent increases, or
percent rent clauses.
Tenancy – A real estate investment is basically a portfolio of leases. The lease terms
and conditions, type lease, creditworthiness of the tenants, and quantity, quality, and
durability of the income stream all impact the risk associated with the investment.
Reserve Allowance – We have found that in most Southeastern markets, including
Memphis, reserve allowances are not typically included as an operating expense by
buyers, sellers, or brokers for most property types. The exceptions are apartments,
assisted living, and lodging properties. However, at your request, we have reflected
these rates both with and without reserves as an expense item for a number of
property types.
DIRECT CAPITALIZATION STRENGTHS AND WEAKNESSES
An overall rate is applied to the net operating income through the process called direct
capitalization. As discussed, the cap rate is typically applied to a stabilized or typical operating
year NOI. There are certain strengths and weaknesses in utilizing an overall rate in property
valuation. The strengths are:
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Satisfies all of investors’ return requirements, that is, return on and of the investment.
Simple and easily understood and applied.
Reliable for income streams without variable income growth rates.
Widely used.
There are also certain weaknesses that need to be understood regarding the application of an
overall rate.
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Difficult to apply to an un-stabilized income stream due to vacancy or significant
spikes in market rents.
Difficult to apply to single or multi-tenant properties with long term leases that have
substantial near term risk of roll-over of tenants.
Inconsistency of application regarding the calculation of NOI and reserves.
In the current market there is some level of uncertainty and agreement as to
acceptable rates of return and deal pricing among market participants.
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PROPERTY CLASS TRANSITION
Over time, properties tend to transition between quality classes. That is, a new property rated a
class A grade at its completion may transition to a class B after five or ten years depending on
market conditions. Likewise, a class B property that receives significant capital infusion may
upgrade to a class A rating. The determination of property class or quality is based upon the
analysis of several factors including location, size, age, quality and condition, occupancy and
tenancy, and rent levels. To a large extent, these factors are controlled through asset
management, maintenance and capital expenditures. However, external factors such as new
supply, changing economic conditions, design and amenities can also cause a property to
transition between classes. As such, it is necessary to review property class ratings periodically
to insure that each is properly categorized.
The property classifications will be identified subsequently herein in the individual property type
discussions to follow. The purpose of this study is to develop estimated cap rates for each class
or quality of the core property types. The classes of property are commonly referred to as being
A, B, or C class property. Shelby County requested rates on class D properties as well. Surveys
and investors do not involve themselves with this low quality of asset and cap rates for the low
end classes then based solely on market transactions and our judgment.
Finally, it is important to note that this assignment did not allow for the authors of this study to
inspect any of the properties that were selected as market transactions. Our conclusion as to class
of property is subjective and based on age of the improvements, photographs of the property (if
available), and our discussion with the verifying source of the sale.
CAPITALIZATION RATES SPREADS
It is not possible to generate a sufficient number of sales for each property type and for each
class from available market data in Shelby County. The sales we researched provided too a wide
spread in cap rate data. Thus, since the available database from the marketplace is limited and
somewhat imperfect, especially for the Class C and D properties, we have also analyzed the
potential spread between property classes by employing separate techniques. These alternative
techniques are:
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Investor surveys reflecting A and B class properties,
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A capitalization rate analysis on 60 regional mall sales from 2007 and 2008. These sales
provide Class A, B, C and D properties for analysis directly from the market.
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The spread in yields between 10-year corporate bonds and 10-year Treasury Bills. This
spread will track the risk premium associated with the various investment grades above a
“safe investment”, Treasury Bills. We realize that corporate bonds and Treasury Bills are
not real estate and that the risk of owning real estate is generally regarded as higher than
corporate bond for liquidity and marketability reasons, but the spreads provide some
guidelines for us in establishing risk premiums for different grades of real property above
a base line, Class A properties.
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Finally, the Korpacz Survey reports Institutional versus Non-Institutional grade cap rates
which are generally A/B versus C class or lower.
Regional Mall Cap Rate Spreads
Our research of recent national regional mall transactions yielded sales from January 2007 to
July 2008 and provided cap rates on Class A, B, C, and D regional malls. We used this analysis
as a guide to assist us in analyzing the spread between appropriate cap rates for other types of
properties. The chart below presents the details of this analysis.
NATIONAL REGIONAL MALL
CAPITALIZATION RATE
Property Class
Low
High
Average
Class A
5.0%
5.5%
5.25%
Class B
6.0%
7.2%
6.7%
Class C
8.2%
9.9%
9.06%
Class D
14.25%
15.8%
15.0%
Using the rates above, a range for spreads is indicated for each class. The malls were rated based
on in-line sales per square foot, age, occupancy, tenant mix, and other factors. The chart shows
the range that can occur within class rankings, such as the 145 average spread of basis points
between a Class A and B malls; 381 basis points between a Class A & C malls; and 975 basis
point spread between a Class A and D malls. The chart also shows that the spread increases
between classes of property as the class quality decreases from A to D.
Corporate Bond Yield Spread
To reiterate, we realize that the risk of owning real estate is generally regarded as higher than
corporate bond for liquidity and marketability reasons. However, the spreads between corporate
bonds and 10-Year Treasury Bill yields provide some guidelines for us in establishing risk
premiums for different grades of real property above a base line, Class A properties.
We consider a Class A property to be the benchmark in terms of investment appeal because if its
attributes like age, quality, tenant mix, and strength/longevity of the income stream. Therefore,
Class A properties typically have the lowest overall capitalization rates. Class B, C, & D real
properties tend to have higher overall capitalization rates than Class A properties because they
are inferior in terms of one or more of the aforementioned attributes.
Since we found few recent sales of Class D properties with overall capitalization rates, we used
the risk premium or yield spread over 10-year Treasuries as one of the guides to aid in
establishing an appropriate overall capitalization rate for Class D real estate. The following chart
summarizes the spread between the yields on 5-year and 10-year corporate bonds and the 10-year
Treasury Bill yield as of 10/7/08. This chart was provided by bondsonline.com and is based on
Thomson Reuters, Inc. data.
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The 10-year Treasury Bill is considered the benchmark because it is judged to be a highly safe
investment and bond spreads or differences in bond yields are calculated daily. For consistency,
we focused on the 5- and 10-year maturity terms since this is generally considered to be the
typical holding period for most real estate investors. We have used these spreads as a guide in
helping to select overall capitalization rate ranges.
Reuters Corporate Bond Spread Tables
Reuters Corporate Spreads for Industrials - In Basis Points
10/7/2008
Rating
Aaa/AAA
Aa1/AA+
Aa2/AA
Aa3/AA-
5 yr
185
190
200
215
10 yr
160
170
190
215
A1/A+
A2/A
A3/ABaa1/BBB+
Baa2/BBB
230
250
290
330
360
245
255
275
330
355
Baa3/BBBBa1/BB+
Ba2/BB
Ba3/BBB1/B+
B2/B
B3/BCaa/CCC+
425
535
660
700
755
950
1000
1025
385
550
600
635
680
700
1050
1100
US Treasury Yield
2.45
3.5
Reuters Corporate Spreads for Transportations - In Basis Points
10/7/2008
Rating
Aaa/AAA
Aa1/AA+
Aa2/AA
Aa3/AA-
5 yr
165
180
200
215
10 yr
165
185
200
215
A1/A+
A2/A
A3/ABaa1/BBB+
Baa2/BBB
230
240
250
275
290
225
240
245
255
285
Baa3/BBBBa1/BB+
Ba2/BB
Ba3/BBB1/B+
B2/B
B3/BCaa/CCC+
300
505
520
530
580
685
790
850
315
545
610
630
645
660
720
815
US Treasury Yield
2.45
3.5
Reuters Corporate Spreads for Utilities - In Basis Points
10/7/2008
Rating
Aaa/AAA
Aa1/AA+
Aa2/AA
Aa3/AA-
5 yr
245
265
275
290
10 yr
265
285
295
310
A1/A+
A2/A
A3/ABaa1/BBB+
Baa2/BBB
300
315
325
365
375
340
345
365
385
400
Baa3/BBBBa1/BB+
Ba2/BB
Ba3/BBB1/B+
B2/B
B3/BCaa/CCC+
390
470
600
700
800
900
1050
1150
410
490
690
780
920
1020
1120
1220
US Treasury Yield
2.45
3.5
BondsOnline (http://www.bondsonline.com); FT Interactive Data
13
We found that rating agencies typically give corporate bonds a quality rating that ranges from A
to C, based on their underwritten risk; an A rating is the best. There are then numerous levels of
each rating, for example, the highest rating is AAA but there are also AA+, AA, & AA- in the
top tier of ratings. See the previous charts. The lowest rating for investment grade bonds is BBB
class. We found that Corporate Bonds with ratings below BBB are now considered “junk bonds”
or not investment grade. “Junk bonds” have the highest yield or return because they are
perceived to (and do) present the investor with the highest risk. From a risk premium standpoint,
typically the marketplace assigns an equivalent risk of a 10-year, BBB rated bond to a “good”
class A or B real estate deal as a comparative measurement.
We focused our attention on Industrial corporate bonds. The yields and spreads for the other two
categories of bonds (Transportation & Utilities) are similar to the industrial spreads. We
separated the ratings for industrial corporate bonds, in the aforementioned chart, into three
groups:
•
The first group (AAA through AA-) includes bonds that are considered slightly more
risky than 10-year Treasuries. The chart shows the yield premiums needed to attract
investors to these bonds. The spread ranges from 160 to 285 basis points over the yield
offered by the 10-year Treasury Bill.
•
The second group of bonds (A+ through BBB) includes bonds that are still “investment
grade” but considered more risky bonds in the first group or the 10-year Treasuries. The
previous chart shows the yield premium needed to attract investors to these bonds. The
spread ranges from 225 to 285 basis points over the yield offered by the 10-year Treasury
Bill.
•
The third group of bonds (BBB- through CCC+) are below “investment grade” and are
now considered to be “junk bonds”. They are perceived to be more risky than either of
the previous two groups or the 10-year Treasury Bill. The basis point spread that is
shown in the previous chart represents the yield premium needed to attract investors to
these bonds. The spread is much wider here because to the wider variations of risk faced
by the investor. The spread ranges from 385 to 1,100 basis points over the yield offered
by the 10-year Treasury Bill.
14
Summary
In the previous two sections of the report we examined other guides that we considered to help
us establish cap rate ranges, especially for Class D properties since we found very few recent
sales of Class D properties with overall capitalization rates.
¾
First we examined a large database of regional mall sales and found progressively larger
basis point spreads in the overall capitalization rate range between Class A properties and
Classes B & C malls. The basis point spread between Class A and Class D malls was about
975.
¾
Next we analyzed the spread in yields between 10-year Treasury Bills and corporate
bonds. We found that the yield spread between the 10-year Treasury Bills as of 10/07/08
and the lowest rated bonds (below investment grade) ranges from 375 to 1,100 basis
points. This is, admittedly, a broad range but it covers a broad group of bond ratings that
represent significant differences in expected risk to the investor. We believe that the high
end of the range would represent the difference or risk premium between a Class A
investment and a Class D investment.
In the final analysis, this data suggests that a spread of 400 to 800 basis points to be a reasonable
range for the risk difference between a Class A and Class D real estate investments. We have
considered this in our conclusions. Again, we realize that the risk of owning real estate is
generally regarded as higher than the risk of owning a corporate bond for liquidity and
marketability reasons. For this reason, our analysis using the basis point spread starts with the
overall capitalization rate that is deemed appropriate for a Class A property and adds a premium
for the perceived additional risk by property class.
15
MEMPHIS ECONOMIC OVERVIEW
Known as “America’s Distribution Center”,
Memphis is a transportation hub located in
western Tennessee, served by two interstate
highways (I-40 and I-55), Memphis
International Airport and the Mississippi River.
Two-thirds of a new outside expressway loop is
completed (Nonconnah Parkway & Paul Barrett
Parkway) and another interstate highway (I-69)
is planned. Shelby County is the primary
county in the MSA, which includes two other
counties in Tennessee (Fayette and Tipton), one
in Arkansas (Crittenden) and one in Mississippi
(DeSoto). The metro area comprises nearly 1.3
million residents and 642,000 jobs, according to Moody’s Economy.com. The economic base,
demographics, and future outlook of metro Memphis are summarized in the following
discussions.
ECONOMIC BASE
The Memphis economy has stalled and is at or near recession. Factors contributing to this
condition are the national economic slowdown, a weak housing market, the mortgage industry
meltdown, and sustained high energy costs, increased competition from other mid-tier cities.
Local job growth sputtered along in the early 2000s gaining some positive momentum in 2005
and 2006 before the capital markets unraveled in August 2007. Since that time the local housing
market has fallen in both permit activity and pricing, and local job growth has also decreased,
particularly in the areas of construction, finance, manufacturing, trade, and information. The low
unemployment rate remains one of the few bright spots in the local economy.
ECONOMIC INDICATORS - MEMPHIS MSA
2001
Gross Metro Product (Billions)
Population (Thousands)
Population Change
Employment (Thousands)
Employment Change
Unemployment Rate
2002
2003
2004
2005
2006
2007
2008 (Est.)
41.8
43.5
44.6
45.3
46.3
47.8
48.5
49.1
1,215.3
1,224.3
1,234.3
1,243.8
1,254.5
1,271.7
1,280.5
1,290.4
---
9.0
10.0
9.5
10.7
17.2
8.8
9.9
619.2
613.1
616.6
616.5
626.6
637.3
642.7
642.0
---
(6.1)
3.5
(0.1)
10.1
10.7
5.4
(0.7)
4.4%
5.3%
5.9%
5.9%
6.1%
5.6%
5.2%
6.2%
Personal Income Growth
5.2%
3.2%
3.1%
5.7%
4.8%
5.6%
5.2%
4.5%
Single-Family Housing Units
6,446
7,462
8,547
8,890
9,710
8,615
5,676
3,245
Multi-Family Housing Units
1,612
1,622
1,058
1,240
1,082
1,636
2,402
300
$124,900
$128,900
$133,400
$135,600
$140,900
$142,200
$136,400
$111,600
Mortgage Originations (Millions)
$6,901
$7,675
$11,043
$7,865
$7,835
$7,552
$6,042
$4,571
Personal Bankruptcies
20,930
22,813
23,325
21,887
24,483
12,550
14,848
15,777
Existing Home Prices
Source: Moody's Economy.com
16
Memphis is primarily known as a major distribution center. Industries supporting distribution
activity – transportation and wholesale trade – represent 16% of the local economy. The local
economy, however, is more diversified than distribution, as indicated in the following table of
employment composition for the Memphis MSA in 2007. Industry sectors representing at least
10% of the local economy are government, professional and business services, education and
health care, retail trade, and transportation and utilities. During the first half of 2008, consumerbased industries have declined, but government and many service industry sectors are growing.
Memphis Employment Composition
13.8%
Construction
3.9%
8.2%
Manufacturing
Transportation/Utilities
3.8%
10.2%
Wholesale Trade
Retail Trade
Information
9.9%
5.8%
Financial Activities
Prof. & Business Services
Educ. & Health Services
11.3%
12.0%
1.2%
13.0%
5.2%
Leisure & Hosp. Services
Other Services
Government
DEMOGRAPHIC TRENDS
The Memphis MSA population is approximately 1,292,000, according to Claritas, a figure that is
on par with the Moody’s figure cited earlier. Population growth is generally slow, steady, and in
line with national growth rates. Shelby County, the primary county in the MSA, dominates the
region, representing 72% of population. As is typical of larger metro areas, the primary county
is growing at a much slower clip than the surrounding suburban counties. And, the City of
Memphis is experiencing stagnation, as indicated by declining growth rates. The following table
shows key demographic characteristics and trends. Notable factors are:
•
•
Memphis is relatively young with a median age of around 35 years old. The largest age
cohort group is 35-44 years old (14%), followed by 25-34 years old (13%). The senior
population (65+ years old) represents just over 10% of the population, significantly lower
than the State or the nation. It is also a racially diverse community, essentially split 50/50
between white and minority groups for the MSA, with a higher minority population in the
County (60%) and in the City (72%). The minority groups include African Americans
(45.7%) and Asians/other races (3.4%), as well as Hispanics of any race (3.6%).
Memphis is a middle class community with an average household income of
approximately $60,000. More people earn under $15,000 per year (16%) than over
$100,000 (14%), while the largest group earns between $50,000 and $75,000 (19%).
17
Incomes are higher in the County ($61,200) and lower in the City ($48,400), compared to
the MSA.
•
Memphis tends to be a family-oriented community which is illustrated by the household
size, percentage of family households, and propensity toward home ownership. Shelby
County reports the highest home values ($124,300), which are 35% higher than the City,
but only 2% higher than the MSA.
DEMOGRAPHIC CHARACTERISTICS AND TRENDS
City of
Shelby
Memphis
Memphis
County
MSA
Tennessee
USA
Population Trends
2008
632,780
916,454
1,292,475
6,135,887
304,141,549
Annual % Change 2000-2008
-0.3%
0.3%
0.9%
0.9%
1.0%
Annual % Change 2008-2013
-0.3%
0.3%
0.8%
0.9%
1.0%
Population Profile (2008)
Median Age
% Under 18 Years Old
33.99
35.00
34.92
37.47
36.67
27.5%
27.5%
27.1%
23.6%
24.4%
% 65+ years Old
10.9%
10.2%
10.4%
13.1%
12.7%
% Minority Population
72.4%
57.9%
50.6%
21.4%
27.3%
Average Household Income (2008)
$48,412
$61,188
$60,125
$56,612
$67,918
Households (2008)
246,591
348,962
488,143
2,454,617
114,694,201
2.50
2.57
2.60
2.44
2.58
62.5%
67.6%
70.0%
69.5%
68.3%
Average Household Size
% Family Households
Owner-Occupied Housing
55.9%
64.2%
67.4%
70.8%
67.1%
Average Home Value (2008)
$91,798
$124,311
$121,677
$124,316
$178,626
Source: Claritas
FUTURE OUTLOOK
Memphis offers several strengths as a business location. It has an excellent transportation
system, including highways, airport, rail, and river. This transportation system includes the
world’s largest air cargo airport, and the nation’s 4th largest inland port. The local economy is
diverse and the cost of doing business is low, including low real estate rates relative to other
large metropolitan areas, and a relatively low local tax burden. Another bright spot is the small,
but growing biotechnology manufacturing sector, which adds high-paying jobs to the local
economy.
18
Memphis also has several challenges, most notably its sensitivity to economic cycles and
sluggish growth even in good times. It is highly dependent on one large employer – Federal
Express Corporation (30,000 jobs); the next largest private-sector employer is just over one-third
this size. While Memphis has a well-developed distribution network, the high energy costs are
placing a burden on the transportation industry, as well as on consumers. Consumers are also
impacted by the challenging housing market, which probably the single biggest factor in
impeding economic growth.
TOP 10 PRIVATE EMPLOYERS - MEMPHIS MSA
No.
Employer
Local Jobs
1
Federal Express
30,000
2
Baily's Tunica & Resorts
13,000
3
Methodist Healthcare
8,717
4
Baptist Memorial Healthcare
6,585
5
Naval Support Activity-Mid-South
6,372
6
Wal-Mart Stores
6,000
7
Harrah's Entertainment
5,541
8
Univ. of Tennessee Health Sciences Center
3,750
9
The Kroger Company
3,500
10
First Horizon National Corp.
3,423
Source: Moody's Economy.com
Memphis is forecast to perform on par with the nation over the next four years, following a
downturn in 2008. According to Moody’s Economy.com, the local economic slowdown is
expected to continue through 2009, followed by respectable job growth in 2010 (10,400), 2011
(7,700), and 2012 (4,200). In addition, the population is also forecasted to grow by 41,700 new
residents by 2012. These projections indicate the economic decline should bottom out in 2008
and 2009, followed by a more favorable outlook.
The following sections will present a brief overview of the individual asset class market
conditions and the results of the capitalization rate analysis.
19
OFFICE PROPERTIES
OFFICE MARKET CONDITIONS
MEMPHIS OFFICE MARKET TRENDS
Year
2002
2003
2004
2005
2006
2007
2008
Existing SF
44,702,339
45,160,292
45,605,853
45,887,505
46,059,288
46,220,927
46,800,764
Vacant SF
Direct
Total
4,820,866
5,217,983
4,856,260
5,247,859
6,144,165
6,384,930
5,822,059
6,127,186
5,340,237
5,716,661
5,210,252
5,567,413
5,528,922
5,809,238
Vacancy
Rate
11.7%
11.6%
14.0%
13.4%
12.4%
12.0%
12.4%
Net
Absorption
724,801
428,077
(691,510)
539,396
582,308
310,887
338,012
2,231,971
Deliveries
1,046,817
457,953
503,761
286,152
171,783
161,639
579,837
3,207,942
Under
Construction
695,927
449,351
266,924
125,383
333,639
531,537
158,520
Quoted
Rent/SF
$15.64
$15.62
$15.80
$16.05
$16.10
$16.81
$17.41
Source: CoStar Group, Inc. (4th Quarter 2008)
Memphis has an office inventory of 46.8 million square feet. As of year-end 2008, the market
recorded 5.8 million square feet of vacant space representing an overall vacancy rate of 12.4%.
Approximately 280,000 square feet of the vacant space is sublease space, representing 4.8% of
vacant space. During the first half of 2008, the market experienced a net loss of almost 168,000
square feet in net absorption, which is indicative of deteriorating market conditions.
Costar’s office data include owner-occupied space, which encompasses approximately half of
office inventory according to local brokers. The inclusion of owner-occupied buildings may
artificially overstate market performance, particularly with vacancy and absorption; however,
overall trends are still relevant because the historic data are consistent. In addition, many
national and institutional investors rely on CoStar data to provide consistent market information
across a broad spectrum of markets nationwide. So, while the methodology utilized by CoStar
may be flawed, the broad market trends and concepts from these data do provide a relevant
indication of the local Memphis market.
Significant office trends, based on the CoStar information are summarized below:
•
•
Since 2002, a total of 3.2 million square feet have been added to the market, averaging
approximately 458,000 square feet per year. By contrast, net absorption has totaled 2.2
million square feet or approximately 319,000 square feet annually. This has caused the
vacancy rate to remain at unhealthy levels.
The Class A market is faring better than the market as a whole. Class A space totals 10.2
million square feet, representing 22% of total office space. Since 2002, Class A
absorption has totaled 2.3 million square feet, with an annual average of 326,000 square
feet – higher than average annual absorption for the entire office market – which means
that the Class B and Class C markets are losing occupancy as the market shifts to higher
quality space. The Airport and Northeast submarkets are the weakest performers with the
greatest negative absorption.
20
MEMPHIS OFFICE ABSORPTION BY SUBMARKET
Submarket
385 Corridor
Airport
DeSoto Co.
Downtown
East
Midtown
North
Northeast
Total
Class A
275,398
0
7,953
64,997
132,720
(6,793)
0
(144,429)
329,846
Class B
19,094
(236,693)
5,780
(10,812)
(76,736)
103,668
17,511
(30,429)
(208,617)
Class C
(35,735)
(48,151)
5,074
313,341
(18,811)
(4,507)
(4,783)
10,355
216,783
Total
258,757
(284,844)
18,807
367,526
37,173
92,368
12,728
(164,503)
338,012
•
•
•
Office rents in Memphis are typically quoted on a full-service basis. The average quoted
rent is $17.41 per square foot. Class A rents are higher, averaging $19.77 per square
foot, while Class B rents average $17.56 per square foot. Office rents have remained flat
in the Memphis market, growing at less than 2% annually since 2002. Rents are likely to
remain flat until the market reaches equilibrium with a vacancy rate of around 10%.
The dominate office submarket is the East Memphis submarket, which accounts for 24%
(11.3 million square feet) of office inventory. This area includes the wealthier residential
neighborhoods extending from Midtown to Germantown. This submarket has a
significant portion of Class A space (3.3 million square feet) and the highest rents. Class
A rents in this submarket average nearly $25.91 per square foot. Downtown Memphis is
the largest office submarket with nearly 13.4 million square feet. This market is
dominated by older Class B and Class C office buildings – and a lot of uncompetitive
government buildings and other owner-occupied buildings. On the positive side, this
submarket has among the lowest vacancy rates in the market and has achieved strong
absorption during 2008. The 385 Corridor area in Southeast Memphis is another
significant submarket. It is the most balanced local submarket with a low vacancy rate
and the second highest net absorption.
Comcast signed a lease for 60,000 square feet in a 385 Corridor submarket building in
2007; and Hunter Fan took another 60,000 square feet of leased space in 2008. These
two transactions represent the most significant office leases signed in the Memphis
market during the last 24 months. Other significant leases exceeding 25,000 square feet
include: Apperson Crump & Maxwell, GTx, Morgan Keegan, Mass Mutual, SSR Ellers,
and Trumbull Laboratories, and the US Government (GSA).
21
MEMPHIS OFFICE MARKET BY SUBMARKET
Submarket
385 Corridor
Airport
DeSoto County
Downtown
East
Midtown
North
Northeast
Total
Existing SF
6,469,442
5,772,845
1,413,054
13,469,046
11,269,134
3,648,664
1,378,654
3,379,925
46,800,764
Vacant SF
546,044
1,320,734
240,309
1,084,890
1,564,417
315,356
213,520
523,968
5,809,238
Vacancy
Rate
8.4%
22.9%
17.0%
8.1%
13.9%
8.6%
15.5%
15.5%
12.4%
Net
Absorption
258,757
(284,844)
18,807
367,526
37,173
92,368
12,728
(164,503)
338,012
Deliveries
295,466
0
10,400
0
270,371
0
3,600
0
579,837
Under
Construction
3,800
0
6,738
0
147,982
0
0
0
158,520
Quoted
Rent/SF
$20.14
$14.97
$18.98
$15.27
$19.64
$14.94
$14.12
$18.03
$17.41
Source: CoStar Group, Inc. (Year-end 2008)
OFFICE CLASS DESCRIPTIONS
Office buildings are analyzed and researched by class of property classifications. The “class” of
property, ranged from class A to class D. Office building class is more adequately described in
the following summary:
Class A
A relatively new building or an older building that attracts high-quality tenants
and upper-tier rental rates. These properties have the following attributes:
• The highest quality of construction and finish,
• A prime location in relation to other projects,
• Are very professionally managed and maintained,
• Normally have higher occupancy rates than other projects.
• In the final analysis, an office building can be classified as an “A”
property if it is located in an “A” location and achieves “A” rents.
Class B
A relatively new building of good quality or an older building that is completely
renovated and updated. It has the most or all of following characteristics:
• It is well located with good visibility,
• It has above-average finish in space,
• It is at or above moderate occupancy levels and rents,
• It is well managed and maintained, and
• It has good quality class of tenants
Class C
A lesser quality newer building or older renovated building in average condition
with minimal functional deterioration and obsolescence. It has all or most of the
following characteristics:
• Generally a non-prime location,
• It has moderate to average occupancy levels,
• It has moderate to average rental rates for the area,
• It is a well-managed building,
• It is considered to be “average” for the marketplace
22
Class D
These properties are below average newer or older buildings that are reaching the
end of their economic life. They have lower quality of construction and finish
than found in other projects. This type of property may be severely impacted by
physical, functional or economic obsolescence. It has all or most of the following
characteristics:
• Lower occupancy rates,
• Lower rental rates,
• Often in need of extensive renovation or repair,
• Usually in non-prime location,
• Below-average management quality,
• Lower quality of tenants on leases of short duration, and
• Minimal rent; often being operated on a break-even basis; and may not be
producing positive cash flow.
OFFICE INVESTOR SURVEYS
The following table summarizes the overall cap rate results of the national investor survey data
for office product.
OFFICE CAP RATES - INVESTOR SURVEYS
URBAN/CBD
Survey
SUBURBAN
Class A
Class B
Class C
Class A
Class B
Class C
2008 – 4th Quarter
7.14%
8.73%
---
7.59%
8.91%
---
6.64%
8.06%
---
7.2%
8.67%
---
6.94%
8.63%
---
7.63%
8.98%
---
9.63%
---
---
8.86%
---
---
National Markets
7.20%
---
---
7.40%
---
---
Memphis Market
7.00%
---
---
7.40%
---
---
Korpacz*
RealtyRates.com (4th Quarter 2008)
Real Estate Research Corp. (1st Quarter 2008)
*
Korpacz reports institutional and non-institutional grade versus Class A and B property types.
We believe that office product is best compared, from an overall capitalization rate perspective,
based on class of space. This is the method used by the Investor Survey publications. However,
if overall capitalization rates for office sales are sorted by size, if is difficult to use the Investor
Surveys as a guide because they are sorted only by class of space only.
23
OFFICE OVERALL RATES CONCLUSION FROM SALES-BASED ON SIZE
In our previous reports, we provided overall capitalization rate conclusions for office properties
based on their size and then by class within each size range. To be consistent and at your request,
we have again provided the data in that format. However, as mentioned above, we believe that
categorization by property class is a more appropriate methodology. This is because one of the
more important criteria for judging the class of an office property is its age; there is typically a
direct relationship between age and the level of finish, design, location and other features that
attract tenants. While there are certainly exceptions, we generally find that Class A properties
typically are less than 10-years old, Class B properties are 10-20 years old, Class C properties are
20-30 years old, and class D properties are grater than 30 years old.
The following chart summarizes our findings. It is based on the 29 office sales that we
researched. There are blanks in this chart where there was not enough recent sales data to make a
decision based purely on the sales that we found.
The calculation of net operating income and overall capitalization rates from sales and the
investor surveys (shown above) do not include tenant build-out allowance or leasing
commissions as an expense. Also, it is industry standard for this property type to reflect overall
capitalization rates without reserves as an expense item.
Selected Overall Capitalization Rates Based on Sales-Office
Property Class
A
Offices (Greater than 200,000 s.f.)
Without Reserves as Expense
B
C
D
7.00%
to
7.50%
7.50%
to
8.50%
Offices (100,000-199,999 s.f.)
7.00%
to
7.75%
7.50%
to
8.50%
Offices 50,000 to 99,999 s.f.)
7.00%
to
7.50%
7.50%
to
9.00%
9.00%
to
10.00%
Offices 49,999 s.f. and under
7.00%
to
7.50%
7.50%
to
8.50%
8.00%
to
9.00%
Note: The industry standard is to report capitalization rates excluding reserves as an expene item
24
BROKER INTERVIEWS
The sales were closed during 2007 and 2008; most were in 2007. Most of the sales were verified
with either the listing or buyer’s broker. We interviewed them about current market conditions
and found a consensus of opinion that current rates for most types of office properties today are
25 to 50 basis points higher than is exhibited by the more dated sales. This is not surprising given
current market conditions. We considered this when choosing our single point overall
capitalization rates that are shown in the following chart. This is why the single point overall
capitalization rates that are shown below are at the top of the ranges indicated by the sales.
OFFICE OVERALL RATES-CONCLUSION
As noted above, the Investor Survey data is not very useful here because it sorts office properties
by class of space rather than size. We considered it for general rate spreads only. We relied more
heavily on the recent sales, our broker interviews. We also considered the Corporate Bond
Spread Yield Analysis that was previously discussed. The spread in overall capitalization rates
(without reserves as an expense) between Class A and D properties is about 425 to 470 basis
points.
The concluded overall capitalization rates based on both the sales and the recent broker
interviews are summarized below. As mentioned earlier, typical investor surveys do not classify
office properties by age but by class of property. As shown in the chart, it is industry standard for
this property type to reflect overall capitalization rates excluding reserves as an expense item.
However, at the client’s request, we have reflected overall capitalization rate ranges with and
without reserve allowance as an expense.
Concluded Overall Capitalization Rates-Based on Sales & Broker Interviews-Office
Property Class
A
B
C
D
Offices (Greater than 200,000 s.f.)
With Reserves
7.75%
7.45%
8.75%
8.45%
10.50%
10.20%
12.50%
12.20%
Offices (100,000-199,999 s.f.)
With Reserves
7.75%
7.54%
9.00%
8.79%
10.50%
10.29%
12.50%
12.29%
Offices 50,000 to 99,999 s.f.)
With Reserves
7.75%
7.50%
9.00%
8.75%
10.00%
9.75%
12.50%
12.25%
Offices 49,999 s.f. and under
With Reserves
7.75%
7.48%
8.75%
8.48%
9.25%
8.98%
11.50%
11.23%
25
As noted in the previous charts, the industry standard is to report overall capitalization rates
without reserves as an expense item. However, at your request, we have reflected these rates both
with and without reserves as an expense item.
26
INDUSTRIAL PROPERTIES
INDUSTRIAL MARKET CONDITIONS
MEMPHIS INDUSTRIAL MARKET TRENDS BY TYPE OF SPACE
Type
Flex
Warehouse
Total
Existing SF
7,703,023
176,475,661
184,178,684
Vacant SF
1,747,396
23,365,839
25,113,235
Vacancy
Rate
22.7%
13.2%
13.6%
Avg. Annual
Absorption
2002-2008
90,856
3,428,599
3,519,455
Avg. Annual
Deliveries
2002-2008
106,976
3,881,645
3,988,621
Source: CoStar Group (4th Quarter 2008)
MEMPHIS INDUSTRIAL MARKET TRENDS
Year
2002
2003
2004
2005
2006
2007
2008
Existing SF
160,755,931
164,770,892
166,151,881
173,042,552
177,557,037
181,584,276
184,178,684
Vacant SF
Direct
Total
23,371,382
25,595,309
24,429,605
27,490,676
24,612,980
26,706,042
25,191,757
26,644,827
24,488,260
25,777,110
25,692,451
25,962,718
23,979,683
25,113,235
Vacancy
Rate
15.9%
16.7%
16.1%
15.4%
14.5%
14.3%
13.6%
Net
Absorption
731,360
2,119,594
2,165,623
6,951,886
5,382,202
3,841,631
3,443,891
24,636,187
Deliveries
3,808,634
4,014,961
1,380,989
6,941,671
4,809,093
4,151,091
2,813,908
27,920,347
Under
Construction
3,662,025
819,920
3,511,221
4,642,438
2,983,403
2,913,908
952,743
Quoted
Rent/SF
$2.65
$2.64
$2.68
$2.72
$2.69
$2.83
$2.93
Known as “America’s Distribution Center,” Memphis is strategically located in the central
United States to serve about 2/3 of the US population. The Memphis industrial market has an
inventory of 184.2 million square feet, of which 25.1 million square feet are vacant, or 13.6% as
of year-end 2008. Similar to the office market, the CoStar industrial information includes
owner-occupied properties comprising approximately one-third of industrial space, which may
overstate market performance, but provide an indication of overall market trends. Unlike the
office market, the industrial market typically has much more investment by owners-users and
tends to have more single-tenant (owner-occupied) properties; so, owner-occupied industrial
properties create more competition with the speculative industrial market, particularly with
newer product. Relevant trends in the industrial market are summarized below:
•
The warehouse market is the dominant industrial sector representing 96% of total
supply. It includes the distribution segment of the market as well as the bulk warehouse
segment. Since 2002, warehouse inventory has increased by an average of 3.9 million
square feet per year, compared to annual absorption of 3.4 million square feet. This
supply-demand imbalance has caused the vacancy rate to remain relatively high,
exceeding 13%. The majority of development and leasing activity in the warehouse
sector is attributed to larger owner-users. Very little speculative development has taken
place in the last two years, according to local brokers.
27
•
•
•
•
•
The flex market has not fared as well as the warehouse market. This sector comprises
7.7 million square feet, representing only 4% of industrial supply. Since 2002, average
annual deliveries (107,000 square feet) have slightly out-paced average annual
absorption (92,000 square feet), which is positive. However, this industrial sector has
experienced perpetually high vacancy rates, exceeding 20% in the last several years,
which illustrates the underlying weakness in this market. Flex space is primarily located
in two submarkets, each with about 2.7 million square feet of inventory: Northeast and
Southeast. This product tends to be more speculative than the warehouse product, but it
has clearly lost traction in the market.
Average quoted industrial rents are $2.93 per square foot. Although average rents are at
their highest level this decade, they still fall under $3.00 per square foot. Rents have
remained fairly flat, increasing by only 1.7% annually since 2002. Rents vary by type
and class of space. Warehouse rents average $2.69 per square foot. The highest quoted
warehouse rents are in the Northeast submarket, while the lowest are in the Northwest
submarket. Flex rents are higher, averaging $7.88 per square foot, which are highest in
the Northeast submarket and lowest in the Northwest submarket. According to local
brokers, real industrial rents have declined in the last few years due to an increase in
concessions – free rent – with no material changes in face rate.
Southeast Shelby County is the dominant industrial submarket representing nearly half
of supply. This submarket offers the best airport access and proximity to local industrial
giants Federal Express and United Parcel Service. This submarket has a slightly lower
than average vacancy rate and is the market leader in absorption. DeSoto County (MS)
has emerged quickly as Memphis’ third largest industrial submarket due to its Interstate
55 access and spillover from the Southeast submarket. It has garnered most of the new
construction activity. The Southwest submarket is the second largest submarket, but it
has mostly older inventory.
Memphis boasts six large distribution centers exceeding 1.0 million square feet: Brother
International, Ford Motor Company, Hewlett-Packard, Nike, Technicolor Video, and
Williams-Sonoma. Hewlett-Packard has reportedly announced plans to vacate its
Memphis facilities totaling 2.1 million square feet, which is a detriment to the market as
others may follow. Major leases signed in the last 24 months, exceeding 400,000 square
feet include: Cooper Industries, Diamond Comics, DSC Logistics, Mallory Alexander
International Logistics, New Breed Logistics, Phillips Electronics, and ScanSource.
Memphis has attracted several national industrial developers, including Panattoni,
Industrial Developments International, Duke Realty, ProLogis and Champion Partners.
Local developer Belz Enterprises is also an active player. The market sector has also
successfully attracted institutional capital.
MEMPHIS INDUSTRIAL MARKET BY SUBMARKET
Submarket
Crittenden Co.
DeSoto County
Northeast
Northwest
Southeast
Southwest
Total
Existing SF
1,731,120
28,361,902
9,655,207
16,832,639
86,648,176
40,949,640
184,178,684
Vacant SF
378,934
5,564,617
1,087,337
3,267,555
11,244,700
3,570,092
25,113,235
Vacancy
Rate
21.9%
19.6%
11.3%
19.4%
13.0%
8.7%
13.6%
Net
Absorption
293,688
1,064,591
176,434
1,565,848
245,645
97,685
3,443,891
Deliveries
0
1,402,608
65,300
1,100,000
210,000
36,000
2,813,908
Under
Construction
0
452,743
0
0
100,000
400,000
952,743
Quoted
Rent/SF
$3.14
$3.17
$6.61
$1.75
$2.80
$2.43
$2.93
28
WAREHOUSE/DISTRIBUTION CLASS DESCRIPTIONS
There are numerous types of industrial buildings but we focused on warehouse/distribution
because this the most prevalent type of industrial property in the Memphis area. Factors that
determine the classification of warehouse/distribution properties are location, access, site/truck
court configuration, ceiling height, column spacing, overall construction quality, and
percentage/quality of office build out, among other factors.
Class A
A relatively new building or older building that attracts high-quality tenants and
has upper-tier rental rates. These properties have the following attributes:
• The highest quality of construction and finish,
• A prime location in relation to other projects,
• Are very professionally managed and maintained,
• Normally have higher occupancy rates than other projects.
• In the final analysis, a warehouse building can be classified as an “A”
Class B
renovated and updated. It has the most or all of following characteristics:
• Above average quality construction and finish
• Well located with good visibility
• Well managed and maintained
• At or above moderate occupancy levels and rents, and
• Good quality class of tenants
Class C
A lesser quality new building or older renovated building in average condition
with minimal functional deterioration and obsolescence. It has all or most of the
• Typically in non-prime locations
• Normally well-managed building
• Moderate to average occupancy levels
• Moderate to average rental rates for the area
• Considered to be the “average” in the marketplace
Class D
Below average newer or older buildings reaching the end of its economic life.
Lower quality of construction and finish than found in other projects. This
property may be severely impacted by physical, functional or economic
obsolescence. This type of property may be severely impacted by physical,
functional or economic obsolescence. It has all or most of the following
characteristics:
• Usually in non-prime location
• Often in need of extensive renovation or repair
• Below-average management quality
• Lower occupancy rates
• Lower rental rates
• Lower quality of tenants
29
INDUSTRIAL INVESTORS SURVEYS
for industrial product.
INDUSTRIAL CAP RATES - INVESTOR SURVEYS
WAREHOUSE
Survey
FLEX/R&D
Class A
Class B
Class C
Class A
Class B
Class C
6.73%
8.28%
---
7.76%
9.94%
---
6.48%
7.84%
---
7.60%
9.23%
---
6.82%
7.98%
---
7.70%
9.08%
---
8.42%
---
---
10.10%
---
---
National Markets
7.40%
---
---
7.70%
---
---
Memphis Market
7.90%
---
---
8.30%
---
---
Korpacz*
*
INDUSTRIAL CAPITALIZATION RATES FROM SALES
LandAmerica Commercial Services examined 33 total sales of warehouse or distribution
facilities in the Memphis area. The following chart summarizes our overall capitalization rate
ranges based solely on these market transactions. There are blanks in this chart where there was
not enough recent sales data to make a decision based purely on the sales that we found. The
calculation of net operating income and overall capitalization rates from sales and the investor
surveys (shown above) do not include tenant build-out allowance or leasing commissions as an
expense.
Selected Overall Capitalization Rates Based on Sales-Industrial
Property Class
A
Warehouse/Distribution
Without Reserve Allowance
7.00%
to
B
8.00%
7.00%
to
C
9.00%
8.25%
to
D
10.00%
BROKER INTERVIEWS
The sales were closed during 2007 and 2008 and, on closer inspection, we found much less
activity in 2008 than in 2007. Most of the sales were verified with either the listing or buyer’s
broker. We interviewed them about current market conditions and found a consensus of opinion
that current rates for most types of industrial properties today are 50 to 100 basis points higher
than is exhibited by the more dated sales. This is not surprising given current market conditions.
We considered this when choosing our single point overall capitalization rates that are shown in
the following chart. This is why the single point overall capitalization rates that are shown below
are at the top of the ranges indicated by the sales.
30
INDUSTRIAL OVERALL RATES-CONCLUSION
The concluded overall capitalization rates based on both the sales and the recent investor surveys
are summarized below. The reader will note that the investor surveys do not reflect target rates
for Class C or D properties. Therefore, we relied on the spreads between different classes of
properties in the sales data, our interviews with market participants, and the Corporate Bond
Spread Yield Analysis that was previously discussed as guides in selecting appropriate overall
capitalization rates for these lower classes of properties. The spread in overall capitalization rates
(without reserves) between Class A and D properties is 625 basis points.
As noted in the chart, it is industry standard for this property type to reflect overall capitalization
rates excluding reserves as an expense item. However, at the client’s request, we have reflected
overall capitalization rate ranges with and without reserve allowance as an expense.
Concluded Overall Capitalization Rates-Based on Sales, Investor Survey, & Broker Interviews-Industrial
Property Class
Warehouse/Distribution
With Reserve Allowance
A
B
8.25%
7.81%
9.00%
8.24%
C
10.00%
8.65%
D
14.50%
13.15%
31
RETAIL PROPERTIES
RETAIL MARKET CONDITIONS
MEMPHIS RETAIL MARKET TRENDS BY TYPE OF SPACE
Type
General Retail
Malls
Power Centers
Shopping Centers
Specialty Centers
Total
Existing
SF
26,223,008
5,968,113
3,696,811
28,009,676
1,104,929
65,002,537
Vacant
SF
1,276,472
369,146
669,418
3,801,723
254,439
6,371,198
Vacancy
Avg.
Annual
Absorption
Avg.
Annual
Deliveries
Rate
4.9%
6.2%
18.1%
13.6%
23.0%
9.8%
2002-2008
159,292
188,234
39,457
351,451
(2,459)
735,975
2002-2008
426,106
216,307
111,885
568,791
2,432
1,325,521
Source: CoStar Group (4th Quarter 2008)
MEMPHIS RETAIL MARKET TRENDS
Year
2002
2003
2004
2005
2006
2007
2008
Existing SF
57,647,975
59,189,459
59,799,153
61,930,463
63,186,120
63,884,769
65,002,537
Vacant SF
Direct
Total
2,762,399
2,987,904
3,920,311
4,101,461
4,509,540
4,674,750
4,907,937
5,129,716
5,140,238
5,392,704
5,463,804
5,785,761
6,029,407
6,371,198
Vacancy
Rate
5.2%
6.9%
7.8%
8.3%
8.5%
9.1%
9.8%
Net
Absorption
1,180,554
427,927
36,405
1,676,344
992,669
305,592
532,331
5,151,822
Deliveries
824,409
1,541,484
1,494,320
2,276,662
1,275,987
698,649
1,167,138
9,278,649
Under
Construction
1,017,100
1,207,189
2,316,848
948,493
574,770
1,118,424
749,304
Quoted
Rent/SF
$11.93
$12.29
$12.39
$10.50
$10.86
$11.15
$13.29
The Memphis retail market comprises 65 million square feet with a vacancy rate of 9.8%. This
inventory includes owner-occupied space, totaling approximately half of the existing retail space.
While this could overstate overall market performance, owner-users of retail space – which
mostly represent significant anchor tenants – are a key component of the retail market. Since
2002, the overall retail market has delivered 9.3 million square feet, which equates to 1.3 million
square feet annually. New supply has outpaced demand by approximately 4.1 million square feet
during the past seven years, or about 589,500 square feet annually. During this period, a total of
5.1 million square feet (736,000 square feet per year) of retail space has been absorbed. The
vacancy rate has climbed by an astonishing 460 basis points since 2002. Other notable trends are
outlined below:
•
There are eight large regional centers and malls in the Memphis market totaling 5.9
million square feet with a vacancy rate of 6.2%, better than the overall market average.
Half of the centers are classified as regional malls, including Hickory Ridge Mall, Oak
Court, Southland Mall, and Wolfchase Galleria. Primary mall anchor tenants in the
Memphis market are Dillard’s, JC Penney, Macy’s, and Sears. Lifestyle centers, such as
Overton Square are also included in the mall category.
32
•
•
•
•
Power centers, representing 3.7 million square feet, have a vacancy rate of 18.4%. The
vacancy rate has increased by more than 12 percentage points since 2002, which indicates
significant weakness in this sector of the retail industry. While construction has not been
particularly robust in this sector, absorption has been paltry, totaling less than 40,000
square feet annually. These types of centers are anchored by large national “big box”
retailers that are well represented in the Memphis market. And, many are experiencing
store failures, such as Circuit City, Goody’s, and Linens and Things.
Shopping centers, mostly comprised of neighborhood centers, are the largest sector with a
total of 28 million square feet of space, representing 43% of the total retail market. The
high vacancy rate of 13.6% indicates the supply-demand imbalance in this sector. Since
2002, about 569,000 square feet of shopping center space has been delivered annually,
compared to about 351,000 square feet in absorption, which has pushed the vacancy rate
up by five percentage points during this period. The key grocery anchor in the Memphis
market is Kroger, but Super Target and Super Wal-Mart are also significant grocers.
The average quoted retail rental rate is $13.29 per square foot, net of operating expense
reimbursements. Similar to office and industrial rents, retail rents have remained flat,
increasing by only $1.36 per square foot since 2002. The highest average rents are
achieved at malls, with an average of $21.75 per square foot. The other primary sectors
have rents slightly lower than the overall average falling in the $10.00 to $12.00 range
per square foot.
The largest retail submarket in Memphis is Downtown/Midtown, which is also one of the
healthiest in terms of low vacancy and supply-demand balance. This submarket has
undergone resurgence in recent years and has attracted new retail projects as a result.
Southeast is the second largest submarket, but it comprises mostly older retail centers and
is struggling with occupancy and absorption. The East, Southaven, and Northeast
submarkets also have strong retail cores in relatively healthy condition. Not surprisingly,
the highest rents are achieved in the wealthy East and Germantown neighborhoods.
MEMPHIS RETAIL MARKET BY SUBMARKET
Submarket
Existing SF
Vacant SF
Collierville
3,181,446
273,394
Cordova
4,524,257
214,190
Downtown/Midtown
12,413,846
805,484
East
7,646,613
556,401
Germantown
4,437,941
452,730
North
6,402,099
902,352
Northeast
7,022,244
625,936
Olive Branch
1,571,818
155,876
Outlying DeSoto Co.
491,426
62,350
South
3,678,629
405,014
Southaven
5,013,987
495,000
Southeast
8,618,231
1,422,471
Total
65,002,537
6,371,198
Vacancy
Rate
8.6%
4.7%
6.5%
7.3%
10.2%
14.1%
8.9%
9.9%
12.7%
11.0%
9.9%
16.5%
9.8%
Net
Absorption
126,578
19,170
77,678
44,525
78,513
(157,756)
8,208
183,699
31,590
107,349
63,466
(50,689)
532,331
Deliveries
203,388
39,237
63,570
15,000
353,114
0
84,039
205,542
73,300
0
71,948
58,000
1,167,138
Under
Construction
100,000
12,000
11,800
300,000
0
0
0
65,097
0
0
260,407
0
749,304
Quoted
Rent/SF
$12.49
$14.18
$11.79
$22.84
$17.33
$8.99
$13.11
$15.48
$14.88
$7.40
$14.89
$7.78
$13.29
33
RETAIL CLASS DESCRIPTIONS-MULTI-TENANT PROPERTIES
There are many different types of retail properties. We focused our attention on the most
prevalent types in the Memphis area, in terms of total GLA: Regional malls, community/power
centers, neighborhood centers, unanchored strip centers, and single tenant/net leased properties.
¾
The smallest shopping centers are unanchored strip centers and neighborhood centers.
The latter are often anchored by grocery stores.
¾
Community centers are usually larger than neighborhood centers and have several
anchor tenants, often including a large discount retailer.
¾
Power centers are typically larger community center with “big box” retailers as anchor
tenants.
¾
The largest centers are regional malls that draw from the largest trade area and are
anchored by one or more full-service department stores.
Retail properties are generally classified by size of center, types of tenants, and trade area draw
and sales volume generation of the inline tenants. Retail properties are also classified on a scale
of A to D, based on a variety of factors as indicated below.
Class A
This is a relatively new building of good quality or an older building that is
completely renovated and updated. It has excellent trade area demographics and a
location with excellent visibility and/or access. These factors can greatly
contribute to the potential success of the project when compared to others in the
market area. These properties have the following attributes:
• Typically have an effective age of 10 years or less.
• Highest quality of construction and finish
• Prime location in relation to other projects
• Very professionally managed and maintained
• Normally higher occupancy rates than other projects
Class B
renovated and updated. An above average trade area demographics and a location
with good visibility and/or access. These factors can contribute to above average
rents. It has the most or all of following characteristics:
• Typically have an effective age of 10-15 years,
• Good quality construction and finish
• Well located with good visibility
• Well managed and maintained
• At or above moderate occupancy levels and rents
• Above-average finished space
• Good quality class of tenants
34
Class C
This type property has typical trade area demographics and an average location in
terms of visibility and/or access compared to others in the market area. It is
usually a lesser quality or older renovated building in average condition with
minimal functional deterioration and obsolescence. It has all or most of the
• Typically have an effective age of 15-20 years,
• Typically in non-prime locations
• Normally well-managed
• Moderate to average occupancy levels
• Moderate to average rental rates
• Considered to be the “average” in the marketplace
Class D
This type property has below average trade area demographics and a below
average location in terms of visibility and/or access compared to others in the
market area. This class of centers typically includes older, non-renovated
buildings in below average condition, and with some functional deterioration &
obsolescence as well as significant physical deterioration. This type property may
be severely impacted by physical, functional or economic obsolescence.
• Usually in non-prime location
• Often in need of extensive renovation or repair
• Below-average management quality
• Lower occupancy rates
• Lower rental rates
• Lower quality of tenants
RETAIL INVESTORS SURVEYS
for retail product.
RETAIL CAP RATES - INVESTOR SURVEYS
REGIONAL MALL
Survey
POWER CENTER
NEIGHB./COMM. CTR.
Class A
Class B
Class A
Class B
Class A
Class B
6.96%
8.78%
7.75%
---
7.33%
9.36%
6.68%
8.28%
7.13%
---
7.24%
8.65%
6.86%
9.43%
7.14%
---
7.27%
8.79%
N/A%
N/A%
N/A%
N/A%
9.27%
10.00%
National Markets
7.20%
---
7.30%
---
7.50%
---
Memphis Market
7.60%
---
7.70%
---
7.90%
---
Korpacz*
RealtyRates.com (4th Quarter 2008)**
Real Estate Research Corp. (1st Qtr. 2008)
*
**
RealtyRates.com reports anchored (Class A) versus unanchored (Class B) property types.
35
CLASS DESCRIPTIONS-SINGLE-TENANT/NET LEASED PROPERTIES
Single tenant/net leased retail properties typically include branch banks, restaurants, fast food
establishments, drug stores, and big box properties. They are generally classified by building
class/quality but, more importantly, by the strength and longevity of the income stream from the
net lease.
Class A
This is a good quality, relatively new building with an excellent location and trade
area demographics. The existing net lease has one or more of the following
attributes:
¾ Typically 20+years remaining in the term of the lease with multiple
options to renew at a stated rate.
¾ A creditworthy tenant, usually one that is rated by either Standard &
Poors or Moody’s,
¾ Periodic steps in the rent that equal or exceed the perceived level of future
inflation,
¾ NNN or absolute net lease terms,
¾ A property that is well suited and essential to the operation of the tenant.
Class B
This is a good quality, relatively new building with a good location and with good
trade area demographics. This type property typically has one or more of the
previous attributes missing or below the targeted Class A levels.
Class C
This is a good quality building with an average location and trade area
demographics. This type property is often 10+ years old. Usually this type
property has a lease that has less than 10-years remaining on its existing term, a
tenant that is unrated or it is difficult to judge its credit, and less than a NNN
lease.
Class D
This is typically an older building in a below average location and with below
average trade area demographics. This type property is in non-prime location,
often in need of extensive renovation or repair, and a lower quality of tenant with
a lease that expires within the next five-years and has less than NNN structure.
36
NET LEASE INVESTOR SURVEYS
Net lease properties are single-tenant assets that have gained in popularity among investors, both
large and small. Until recently, 1031 exchangers were strong buyers for these properties. As
mentioned above, the strongest net lease investment opportunities are those with mature cash
flow, long-term remaining lease term, periodic rent steps, NNN or absolute net lease terms,
acceptable tenant credit ratings, and desirable location. Tenant credit is probably the biggest
factor in weighing the cap rate, and ultimately the value of net lease deals. Net leased properties
are primarily retail in nature but may also include industrial and office properties.
for net lease product.
NET LEASE CAP RATES - INVESTOR SURVEYS
Survey
Range
Average
Korpacz
6.0-10.0%
7.85%
2007 - 4th Quarter
6.0-10.0%
7.60%
2006 - 4th Quarter
6.0-10.0%
7.65%
Full-service restaurant
8.63-16.16%
12.68%
Fast food restaurant
6.37-15.15%
11.51%
Convenience store/gas station
6.17-13.24%
7.92%
School & Daycare center
6.86-14.13%
9.80%
RETAIL CAPITALIZATION RATES FROM SALES
As mentioned earlier, we focused our researched on five types of retail properties: enclosed
regional malls, power centers/community centers (generally larger than 100,000 square feet with
several national anchors), neighborhood centers (generally between 40,000 and 100,000 square
feet with one anchor), strip centers, and single tenant/net leased retail properties.
Land America examined 59 total sales. The following chart summarizes our overall
capitalization rate ranges based solely on these market transactions. There are blanks in this chart
where there was not enough recent sales data to make a decision based purely on the sales that
we found. The calculation of net operating income and overall capitalization rates from sales and
the investor surveys (shown above) do not include tenant build-out allowance or leasing
commissions as an expense. Also, it is industry standard for this property type to reflect overall
capitalization rates excluding reserves as an expense item. However, at the client’s request, we
have reflected overall capitalization rate ranges with and without reserve allowance as an
expense.
37
Selected Overall Capitalization Rates Based on Sales-Retail
Property Class/Investment Grade
B
C
A
Regional Enclosed Malls
6.50%
to
7.25%
Community/Power Centers
6.50%
to
7.50%
Neighborhood Centers
D
6.50%
to
8.00%
8.50%
to
9.50%
8.00%
to
10.00%
8.75%
to
10.50%
10.00%
to
10.75%
Unanchored Strip Centers
8.00%
to
8.50%
8.50%
to
10.00%
Single Tenant-Net Leased
6.25%
to
7.25%
7.00%
to
8.00%
9.50% to
10.50%
to
15.8%
11.0%
BROKER INTERVIEWS
The sales were closed during 2007 and 2008 and, on closer inspection, we found much less
activity in 2008 than in 2007. Most of the sales were verified with either the listing or buyer’s
broker. We interviewed them about current market conditions and found a consensus of opinion
that current rates for most types of retail properties today are 50 to 100 basis points higher than is
exhibited by the more dated sales. This is not surprising given current market conditions. The
exception to the above premium range is for single tenant/net leased properties where the
premium appears to be smaller at only about 20-30 basis points. We considered this when
choosing our single point overall capitalization rates that are shown in the following chart. This
is why the single point overall capitalization rates that are shown below are at the top of the
ranges indicated by the sales.
RETAIL OVERALL RATES-CONCLUSION
The concluded overall capitalization rates based on both the sales, recent investor surveys, and
broker interviews are summarized below. The reader will note that the investor surveys do not
reflect target rates for Class C or D properties. Therefore, we relied on the spreads between
different classes of properties in the sales data, our interviews with market participants. We also
considered the Corporate Bond Spread Yield Analysis that was previously discussed as guides in
selecting appropriate overall capitalization rates for these lower classes of properties. The spread
in overall capitalization rates (excluding reserves) between Class A and D properties is 300 to
675 basis points, depending on property type.
38
Concluded Overall Capitalization Rates-Based on Sales, Investor Surveys, & Broker Interviews-Retail
A
Property Class/Investment Grade
B
C
D
Regional Enclosed Malls
7.25%
7.08%
8.00%
7.82%
9.50%
9.06%
13.75%
11.88%
Community/Power Centers
7.75%
7.63%
8.50%
8.25%
9.50%
9.00%
14.25%
13.25%
Neighborhood Centers
8.00%
7.85%
9.50%
9.30%
10.75%
10.25%
14.50%
13.50%
Unanchored Strip Centers
9.00%
8.85%
9.50%
9.16%
11.00%
10.53%
13.00%
11.76%
Single Tenant-Net Leased
6.75%
6.67%
8.00%
7.92%
9.50%
9.43%
11.00%
10.27%
without reserves as an expense item. However, at your request, we have reflected these rates both
with and without reserves as an expense item.
39
HOTEL/MOTEL (LODGING) PROPERTIES
LODGING MARKET CONDITIONS
MEMPHIS HOTEL MARKET TRENDS
Average
Occupancy
Year
All Hotels
2003
58.1%
2004
60.1%
2005
65.3%
2006
65.5%
2007
64.1%
2008**
62.4%
Upper-Priced Hotels
2003
58.7%
2004
60.9%
2005
65.1%
2006
65.8%
2007
63.7%
2008**
62.3%
Lower-Priced Hotels
2003
57.5%
2004
59.4%
2005
65.4%
2006
65.2%
2007
64.5%
2008**
62.5%
Average
Daily Rate
RevPAR*
Change in
Supply
Change in
Demand
$67.47
$70.14
$73.22
$80.64
$86.56
$90.23
$39.17
$42.14
$47.79
$52.79
$55.49
$56.32
2.1%
0.4%
1.0%
0.8%
2.9%
3.5%
2.8%
3.9%
9.7%
1.1%
0.7%
0.8%
$83.84
$85.77
$90.35
$100.31
$108.68
$113.62
$49.21
$52.21
$58.83
$65.99
$69.20
$70.75
2.0%
2.2%
1.3%
0.3%
4.6%
3.3%
1.2%
6.0%
8.4%
1.4%
1.3%
1.0%
$54.33
$57.14
$59.29
$64.57
$68.29
$70.85
$31.26
$33.96
$38.78
$42.10
$44.03
$44.31
2.1%
-0.9%
0.7%
1.1%
1.4%
3.7%
4.0%
2.3%
10.9%
0.8%
0.3%
0.6%
* Revenue per available room; average occupancy times average daily rate.
** Annual forecast
Source: PKF Hospitality Research
Memphis has a room supply of 223 hotels and 21,205 rooms (average of 95 rooms per property),
according to PKF Hospitality Research. Upper-priced hotels represent 46.1% of local room
supply while lower-priced hotels account for 53.9% of rooms. Hotels are distributed throughout
four primary submarkets: East Memphis (41.1%), Airport/South Memphis (33.0%),
Downtown/Midtown Memphis (19.5%), and West Memphis (6.4%). Trends shaping the hotel
market are indicated below:
•
By 2003, the Memphis hotel market had recovered from 9/11 and the 2001 national
economic recession and enjoyed a period of prosperity that has continued. Between 2003
and 2007, the average daily rate has increased by more than $19, an average annual
increase of 6.4%. Although the occupancy rate peaked in 2006, it has not fallen quickly
enough to have a negative impact on RevPAR, which is the best measure of hotel
performance. During the last five years, RevPAR has increased by $16.32, or 9.1%
annually – a growth rate well ahead of inflation. The forecast for 2008 shows continued,
albeit slower growth in both average daily rates and RevPAR, with occupancy rates
flattening.
40
•
•
•
•
•
Upper-priced hotels are performing above market with RevPAR increasing by $20
between 2003 and 2007. Memphis has 65 upper-priced properties totaling 1,768 rooms.
A total of 13 properties (1,767 rooms) are planned. Only five hotels in Memphis offer
more than 300 rooms. The largest hotel in Memphis is the famous Peabody hotel with
468 rooms, followed by the Hilton Memphis (405 rooms) and the Marriott Memphis
Downtown (393 rooms). Other upper-priced hotels include Holiday Inn Select,
Doubletree, and Holiday Inn.
Lower-priced hotels are also performing well. Between 2003 and 2007, RevPAR
increased by $12.77, or a healthy annual rate of 8.9%. This sector comprises 158
properties with 11,425 rooms. Another 21 properties (1,736 rooms) are planned,
including 7 properties (661 rooms) under construction. Major lower-priced brands in the
Memphis market include Hampton Inn, Days Inn, Super 8, Holiday Inn Express, and
Comfort Inn.
Memphis’ slogan for tourism is “Home of the blues … Birthplace of rock ‘n roll.” The
City offers several attractions focused on music, including Graceland, Beale Street
Entertainment District, and Delta Blues Museum. Memphis and Shelby County
government leaders have recently formed a music commission to actively recruit and
develop talent and business. Memphis is also one of seven National Academy of
Recording Arts & Sciences (NARAS) districts in the U.S.
Memphis offers several significant convention and meeting facilities to draw group
business to the city. The capstone facility is Memphis Cook Convention Center in
downtown Memphis, a 350,000 square-foot facility offering 190,000 square feet of
exhibit space, 74,000 square feet of meeting space, and a 28,000 square-foot ballroom.
Other significant meeting facilities include Agricenter International, Cannon Center for
the Performing Arts, Mid-South Coliseum, FedEx Forum, and The Pyramid, among
others. The city is a growing sports center, recently attracting the Memphis Grizzlies
NBA team.
Gaming is a growing industry in the Memphis area. Tunica Resorts, one of the area’s
largest employers (second behind FedEx), operates nine casinos within 18 miles of
Memphis in Mississippi, including Circus-Circus, Harrah’s Mardi Gras, Horseshoe,
Sam’s Town, Sheraton, The Grand, Bally’s, Fitzgerald, and Hollywood. This fairly new
local industry does have an impact on tourism.
41
LODGING CLASS DESCRIPTIONS
The following criteria were utilized in classifying lodging properties for this study. In addition,
overall appeal, amenities, daily rate, and affiliation were considered in classification.
Class A
The average “A” property is less than 10 years old (effective age); generally with
full amenities (e.g., food and beverage service, meeting rooms, etc.), average size
rooms, and generating above average rates for the market area. Any two of the
three factors below could push the class to the high ranged “A+” classification.
• Good condition for age.
• Larger than average size room.
• Located in most desirable area.
• Affiliated with an upscale or boutique lodging chain.
Conversely, any two of the three factors below could place the project in the low
range of “A-” classification (all three would lower the category to “B+”).
• Project showing deferred maintenance.
• Smaller than average room.
• Located in less desirable area.
Class B
These properties are approximately 10 to 15 years old (effective age), offering full
amenities. This could also be a newer property in a less desirable area, lower
quality and/or no amenities. Properties with the more desirable locations would
be in the “B+” range A slightly less desirable location and smaller rooms would
put a property in the “B-” range. This type property would also be affiliated with a
major lodging chain but not necessarily one of the more upscale ones.
Class C
These properties are approximately 15 to 20 years old (effective age), of average
quality and condition, with less than typical size rooms and fewer amenities. This
type property would typically be affiliated with a discount or lower end lodging
chain. A property with the aforementioned qualities but one or more above
average attributes would be considered C+.
Class D
Generally, these are properties have an effective age of 20+ years; they appear to
have had little or no remodeling, and have high maintenance and other expenses.
This type property may be severely impacted by physical, functional or economic
obsolescence. It would typically be a “mom & pop” operation with a discount or
low end lodging chain affiliation or no affiliation. Properties in the less desirable
area would be rated at the low “D-” range.
42
LODGING INVESTORS SURVEYS
for hotel product. The Hotel Survey is published in the 3rd Quarter of each year.
HOTEL CAP RATES - INVESTOR SURVEYS
Survey
Range
Average
Korpacz*
2008 – 3rd Quarter
Full-Service
6.0-10.5%
8.50%
Economy/Limited Service
6.5-14.0%
9.83%
Luxury
4.0-10.5%
7.67%
Extended Stay
9.5-13.0%
10.85%
2007 - 3rd Quarter
Full-Service
6.0-10.5%
8.30%
6.5-14.0%
9.58%
Luxury/Upper-Upscale
4.0-10.5%
7.53%
Extended Stay
9.5-13.0%
10.73%
2006 - 3rd Quarter
Full-Service
6.0-10.5%
8.81%
6.5-14.0%
9.83%
Luxury
4.0-10.0%
7.86%
Extended Stay
9.5-13.0%
10.75%
All Types
6.36-17.35%
11.69%
Full Service
6.36-13.87%
9.61%
Limited Service
8.15-17.35%
12.03%
Golf/Gaming/Resort
6.69-16.35%
9.86%
National Markets
7.0-9.0%
8.00%
Memphis Market
---
7.70%
*
43
LODGING CAPITALIZATION RATES FROM SALES
LandAmerica Commercial Services examined 27 total sales of hotel/motels in the Memphis area
and other southeastern cities. The following chart summarizes our overall capitalization rate
ranges based solely on these market transactions. There are blanks in this chart where there was
not enough recent sales data to make a decision based purely on the sales that we found.
SelectedOverall CapitalizationRatesBasedonSales-Hotel &Motel
PropertyClass
A
B
Full Service
WithReserveAllowance
6.50% to
8.50%
Limited/Select Service&ExtendedStay
6.50% to
9.00%
7.50% to
C
9.50%
9.50% to
D
11.50%
Note: Theindustrystandardistoreport capitalizationratesincludingreservesasanexpeneitem, sowehavenot relflectedoverall capitalization
without reserveallowances.
BROKER INTERVIEWS
The sales were closed during 2007 and 2008 and, as might be expected, we found much less
activity in 2008 than in 2007. We interviewed brokers that are active in this product type about
current market conditions and found a consensus of opinion that current rates for most types of
lodging properties today are at least 100 basis points higher than is exhibited by the more dated
sales. This is not surprising given current market conditions. We considered this when choosing
our single point overall capitalization rates that are shown in the following chart. This is why the
single point overall capitalization rates that are shown below are at the top of the ranges
indicated by the sales.
LODGING OVERALL RATES-CONCLUSION
are summarized below. We also considered the Corporate Bond Spread Yield Analysis that was
previously discussed as guides in selecting appropriate overall capitalization rates for these lower
classes of properties. The spread in overall capitalization rates (with reserves as an expense item)
between Class A and D properties is 450 to 650 basis points, depending on property type.
44
ConcludedOverall CapitalizationRates-BasedonSales, InvestorSurveys, &BrokerInterviews-Hotel &Motel
PropertyClass
A
B
C
D
Full Service
8.00%
9.00%
9.50%
12.50%
Limited/SelectService&ExtendedStay
8.50%
9.50%
11.00%
14.50%
Note:Theindustrystandardistoreport capitalizationratesincludingreservesasanexpeneitem,sowehavenotrelflectedoverall capitalization
withoutreserveallowances.
45
MULTI-FAMILY PROPERTIES
APARTMENT MARKET CONDITIONS
MEMPHIS APARTMENT MARKET TRENDS
Year
2003
2004
2005
2006
2007
3QTR 2008
2008*
Existing
Units
72,883
73,748
74,270
74,475
74,897
75,632
75,843
Vacant
Units
7,245
7,162
6,685
7,816
7,785
8,038
8,510
Vacancy
Rate
9.9%
9.7%
9.0%
10.5%
10.4%
10.6%
11.2%
Completions
540
865
522
205
588
581
946
Net
Absorption
588
948
999
(926)
453
(205)
221
Asking
Rent
$610
$625
$635
$646
$663
$676
$678
Effective
Rent
$572
$585
$595
$605
$625
$633
$634
* Year-end forecast
Source: Reis, Inc. (3rd Quarter 2008)
According to Reis, Memphis has an apartment inventory of 75,843 units as of third quarter 2008.
The overall vacancy rate is an unhealthy 11.2%. Preliminary 4th quarter data by Reis show the
Memphis apartment market at an 11.8% vacancy and monthly rents of $675 per month,
illustrating that market conditions continue to decline. Other significant trends are offered
below:
•
•
•
•
The “for sale” housing market has taken its toll on the local apartment market, but this
trend has largely run its course with the current mortgage crises and significant weakness
in the housing market. Between 2001 and 2008, a total of 58,591 single-family housing
units were permitted in metro Memphis, averaging 3,241 per year, according to Moody’s
Economy.com; however, single-family unit permits exceeded 8,500 annually from 2003
through 2006, when the market peaked. Only 3,245 single-family units are expected to
be permitted in 2008. Average prices for homes also peaked in 2005 and 2006,
exceeding $140,000, but prices dropped by 4% in 2007 and another 18% in 2008. The
forecasted average price for 2008 is only $111,600, the lowest level since before 2001.
The poor performance experienced in the single-family housing market should boost the
apartment market as many people move from home ownership back to the renter pool.
The growing “echo boom” population, aged from their mid-teens through 20s, should
also increase demand for local apartments; this generation is near the same level as their
parent’s generation, the Baby Boomers.
The market-wide apartment vacancy rate was generally below 5% before the 2001
national economic recession. Vacant space nearly doubled to a rate of 9.9% at a peak at
year-end 2003 then fell to 9.0% by year-end 2005 as the market recovered. Since that
time the vacancy rate has jumped to an unprecedented more than 10%. With a spike in
new inventory projected during 2008, the vacancy rate is expected to exceed 10% for
some time.
Since 2003, the market has absorbed a total of 1,983 apartment units, averaging 331 units
per year. Conversely, completions have totaled 3,666 units, averaging 611 units
annually. Given that new supply has out-paced absorption by a factor of nearly 2:1, the
vacancy rate should remain high in the near term.
46
•
Asking apartment rents in Memphis average $676 per month; this is 6% higher than
effective rents that take “specials” into account, such as free rent. Asking rents have
increased by $66 per month since 2003, averaging a 2.2% increase per year. Effective
rents have increased by the same annual rate. Average rents per square foot range from
$0.66 to $1.07 per square foot, depending on unit type and size.
MEMPHIS APARTMENT RENTS & SIZES
Unit Type
Studio/Efficiency
One Bedroom
Two Bedroom
Three Bedroom
Avg. Rent
$539
$624
$674
$865
Avg. SF
504
739
992
1,305
Avg. Rent/SF
$1.07
$0.84
$0.68
$0.66
Source: Reis, Inc. (3rd Quarter 2008)
APARTMENT CLASS DESCRIPTIONS
The following criteria were utilized in classifying apartment properties for this study. In
addition, location, property condition, amenities, unit sizes, and monthly rents were considered
in classification.
Class A
full project amenities (e.g., swimming pool, exercise room, clubhouse, business
center, car wash area, garages, tennis/basketball courts, volley ball etc.), and
generating above average rents for the area. Interior finish would be above
average in quality, well maintained, and include many Class A features such as:
fire places, sprinklers, crown molding, upscale kitchen and bath areas. Any two
of the three factors below could push the class to the high ranged “A+”
classification.
• It has an above average condition for its age.
• It has larger than average size unit.
• It is located in most desirable area.
• Well above average finishes.
Conversely, any two of the three factors below could place the project in the low
range of “A-” classification (all three would lower the category to “B+”).
• The project shows deferred maintenance.
• The property has smaller than average unit.
• It is located in less desirable area.
Ultimately, a property older than 10 years can still be classified as an “A”
Class B
These properties are approximately 10 to 15 years old (effective age), and with
many but not all of the attributes mentioned above that categorize a Class A
property.
47
Class C
quality and condition, with average size units, but with fewer amenities than the
Class A & B properties. Properties in the most desirable areas would be at the top
of the range (“C+”).
Class D
Generally, these are properties with an effective age of 20+ years, appear to have
had little or no remodeling, and have high maintenance and other expenses. This
type property may be severely impacted by physical, functional or economic
obsolescence. Properties in the less desirable area would be rated at the low “D-”
range.
APARTMENT INVESTORS SURVEYS
for apartment product.
APARTMENT CAP RATES - INVESTOR SURVEYS
Survey
Class A
Class B
Class C
Korpacz*
2008 – 4 Quarter
th
6.13%
7.53%
---
5.75%
6.67%
---
5.97%
7.06%
---
RealtyRates.com (4
th
Quarter 2008)
All Types
8.89%
---
---
Garden/Suburban Townhouse
8.16%
---
---
Hi-Rise/Urban Townhouse
9.11%
---
---
National Markets
6.70%
---
---
Memphis Market
6.80%
---
---
National Markets
6.00%
---
---
Memphis Market
7.50%
---
---
Real Capital Analytics (1st Quarter 2008)
*
48
MULTI-FAMILY CAPITALIZATION RATES FROM SALES
LandAmerica Commercial Services examined 40 total sales of multi-family properties in the
Memphis area. The following chart summarizes our overall capitalization rate ranges based
solely on these market transactions.
SelectedOverall CapitalizationRatesBasedonSales-Multi-Family
Property Class
Apartments
A
5.75% to
6.50%
B
6.00% to
7.00%
C
7.00% to
8.50%
D
7.50% to
10.0%
Note: The industry standard is to report capitalizationrates including unit reserves as an expene item
BROKER INTERVIEWS
The sales were closed during 2007 and 2008; most were in 2007. Most of the sales were verified
with either the listing or buyer’s broker. We interviewed them about current market conditions
and found a consensus of opinion that current rates for most types of multi-family properties
today are higher than the implied overall capitalization rates from the sales that we researched
but there not as much spread as in other property types. Current market conditions continue to
deteriorate. This is because investors expect that apartment demand will improve as some
homeowners move out of homes due to foreclosure or inability to pay mortgages. We considered
this in our ultimate choice of overall capitalization rate ranges.
MULTI-FAMILY OVERALL RATES-CONCLUSION
properties in the sales data, our interviews with market participants. We also considered the
Corporate Bond Spread Yield Analysis that was previously discussed as guides in selecting
appropriate overall capitalization rates for these lower classes of properties. The spread in overall
capitalization rates (with reserves as an expense item) between Class A and D properties is 375
basis points. The spread is lower for multi-family properties than other property types because
49
the multi-family market does not appear to have been as negatively impacted by the recent
economic and real estate events.
ConcludedOverall CapitalizationRates-BasedonSales, Investor Surveys, &Broker Interviews-Multi-Family
PropertyClass
A
Apartments
Without ReserveAllowance
6.75%
6.90%
B
7.50%
7.99%
C
8.50%
9.36%
D
10.50%
12.60%
Note: Theindustrystandardistoreport capitalizationratesincludingunit reservesasanexpenseitem
including unit reserves as an expense item. However, at your request, we have reflected these
rates both with and without reserves as an expense item.
50
GOLF COURSES
The client has requested that golf courses be added to the Cap Rate Study this year as an
additional property type. This property type will be addressed by utilizing only the
RealtyRates.com investor rate survey and information compiled by the Deloitte Golf &
Recreational Services consulting group. We have not researched individual sales of golf courses
at this time. The Deloitte information is based on sales transactions of golf facilities and the
analysis of the respective operating statements of the clubs. It is noted that the capitalization rates
on golf courses are considered cap rates reflecting the going concern value according to the
Deloitte Survey.
The survey information for the RealtyRates.com 4th 2008 Quarter Investor Survey is shown
below for all types of golf courses.
GOLF COURSE CAP RATES - INVESTOR SURVEY
Minimum
Average
Maximum
All Types
6.44%
12.26%
16.93%
Public Daily Fee
7.71%
11.35%
16.42%
Semi-Private
6.79%
12.12%
16.93%
Private Clubs
6.44%
11.43%
15.77%
The average golf course cap rate has increased from 10.52% in the 2001 survey and has
fluctuated from about 10.66% in 2004 to 12.00% in the 2nd quarter of 2008.
The Deloitte Survey concludes a similar overall average cap rate as compared to the
realtyrates.com data above. The chart below is for all types of golf courses and the reported
broad range is obviously too wide to utilize with any reliability but does show a bracket.
GOLF COURSE CAP RATES – DELOITTE SURVEY*
Broad Range-All Types
Average-All Types
2006
CURRENT
4.85-17.25%
5.25-22.0%
10.68%
11.75%
6.50-15.0%
9.8%
Comparison to 10 Years Ago:
Broad Range-All Types
*Considered Going concern
overall rates. Calculated from
actuals and proforma figures.
51
For informational and analytical purposes, the chart below presents the breakdown of operational
revenue and expenses as a sample for a daily fee type golf course.
52
ASSISTED LIVING FACILITIES
ASSISTED LIVING CLASS DESCRIPTIONS
Class A
full amenities (e.g. private resident rooms, on-site vehicles for group outings,
exercise room, physical therapy program, above average landscaping, library,
group gathering rooms, above average dining area, private rooms for
meetings/family gatherings, on-site management, etc.), and it generates above
average revenue per unit. This type property is typically located in larger
communities that provide a broad potential customer base. They are also typically
larger facilities (above 75 units) so that there are economies of scale to provide
the above referenced amenities.
Class B
These properties are approximately 10 to 15 years old (effective age), offering
some but not all of the above listed amenities, and they could be located in larger
community or a rural community. They may offer semi-private rooms and may
not generate the highest revenue per unit in the area. This class of property is
typically less than 75 units.
Class C
quality and condition. They typically offer semi-private resident units and only a
limited number of the above listed amenities. They are typically smaller than 50
units.
Class D
Generally, these are properties with an effective age of 20+ years which appear to
have had little or no remodeling. They typically offer only small semi-private
resident units or patient ward type housing and they have few of the above listed
amenities. This type property may be severely impacted by physical, functional or
economic obsolescence.
ASSISTED LIVING FACILITY INVESTORS SURVEYS
for assisted living facilities.
ASSISTED LIVING - INVESTORS SURVEYS
Survey
Realtyrates.com
NIC*
2004 - 1st Quarter
Range
Average
6.23%-12.73%
8.14%
8.75%-13.6%
10.90%
* National Investment Center – For the Senior Housing & Care Industries
53
ASSISTED LIVING CAPITALIZATION RATES FROM SALES
LandAmerica Commercial Services examined 17 total sales of assisted living properties in the
southeastern United States. The following chart summarizes our overall capitalization rate ranges
based solely on these market transactions. There are blanks in this chart where there was not
enough recent sales data to make a decision based purely on the sales that we found.
SelectedOverall CapitalizationRatesBasedonSales-AssistedLiving
PropertyClass
AssistedLiving
A
7.00% to
8.50%
B
9.00% to
11.00%
C
10.00% to
D
14.00%
Note: Theindustrystandardistoreport capitalizationratesincludingunit reservesasanexpeneitem
ASSISTED LIVING OVERALL RATES-CONCLUSION
properties in the sales data and our interviews with market participants. We also considered the
Corporate Bond Spread Yield Analysis that was previously discussed as a guide in selecting
appropriate overall capitalization rates for these lower classes of properties. The spread in overall
capitalization rates (with reserves as an expense item) between Class A and D properties is about
625 basis points.
54
ConcludedOverall CapitalizationRates-Basedon Sales&Investor Surveys-AssistedLiving
Property Class
A
Assisted Living
7.75%
7.99%
B
10.00%
10.33%
C
11.25%
11.78%
D
14.00%
14.65%
Note: The industrystandard is toreport capitalization rates includingunit reserves as anexpeneitem
including unit reserves as an expense item. However, at your request, we have reflected these
rates both with and without reserves as an expense item.
55
MOBILE HOME PARKS (MHPS)
The client has requested that Mobile Home Parks (MHPs) be added to the Cap Rate Study this
year as an additional property type. This property type will be addressed by utilizing only the
investor rate survey provided by RealtyRates.com 4th Quarter 2008 survey. We have not
researched individual sales of MHPs at this time.
The survey information for the RealtyRates.com 4th 2008 Quarter Investor Survey is shown
below for all types of mobile home parks.
MOBILE HOME CAP RATES - INVESTOR SURVEY
Minimum
Average
Maximum
6.79%
9.15%
13.62%
All Types
56
SUMMARY AND OBSERVATIONS
On average, capitalization rates have increased over the last year due to a number of real estate
and general declining economic factors. Considering just the Korpacz Survey, targeted overall
rates, depending on property type and class rating, increased from 14 to 50 basis points since the
4th Quarter 2007 Survey. However, our interviews with market participants suggest that the
spreads are greater, based on their most recent experience. Our findings suggest that this trend
could continue for the near-term (1-2 years).
•
In the year since the subprime mortgage crisis and the beginning of the “national credit
crunch”, the availability of funds for debt on real estate investments has almost
disappeared and the national economy has weakened with limited and uncertain signs of
recovery. Most economists and market participants are looking to 2011 for a significant
market turnaround. As a result, most sectors of the commercial real estate market will
experience varying levels and types of market resistance.
•
We have seen a decline in sales activity across all sectors of the real estate market over
the last year. There are several reasons for this phenomenon, the most notable: The lack
of available debt funds, the more conservative underwriting requirements, equity capital
on the “sidelines”, and reluctant buyers.
•
The market data that an appraiser’s relies on is always dated but this factor is especially
important in a market environment like we are facing today. As mentioned above, we
have seen a decline in sales activity across all sectors of the real estate market over the
last year. Further, overall capitalization rates across all segments of the market have
increased. However, with only a limited # of recent sales to use as a guide, we have had
to consider many different data sources to aid in our concluded rates. In a market
environment like we are facing today, we rely heavily on the consensus of opinions of the
local brokers about the current market conditions and achievable overall capitalization
rates.
•
Many sellers have pulled out of the market and many of those that remain are highly
motivated to sell and thus are willing to liquidate at prices they would not accept a year
ago. There are several reasons for this phenomenon, the most notable are: the lack of
available debt funds and buyer’s more conservative underwriting requirements.
•
Leasing activity is down in most sectors of the real estate market over the last year.
Investors appear nervous about the future of the economy, future tenant demand, rent
growth and space needs.
•
The failure of prominent Wall Street firms and national banking firms has lead to further
uncertainty in the market and will increase the supply of available space on the market.
•
Most knowledgeable sources do not expect the problems in the economy or real estate
market to improve for the near-term. Likewise, improvement in debt availability and
lending practices is not forecast for the near-term.
57
COMPARISON OF OVERALL CAPITALIZATION RATE SELECTIONS
We last prepared this survey for the 2004 study. The following chart summarizes the rates
selected for the prior survey with the conclusions from the current analysis.
Noteworthy is that the concluded capitalization rates for the 2008 study as compared to the 2004
study do not show an overall consistent pattern of change from core property types or for
property class within the property types. There are some discernable patterns that can be
extracted from the data. For instance, in the Class A category, the cap rates are lower in 2008
than in 2004 for each property type. In the Class B category, this downward trend is exhibited for
most property types and classes of property. For Classes C and D the results are mixed, but in
general the high end of the concluded cap rates for these classes is lower than in our 2004 study.
58
Overall Rate Comparison 11/2004 & 10/2008
Property Type/Class
Office -200,000 S.F. & Larger
Class A
Class B
Class C
Class D
Nov-04
Oct-08
(Without Reserves as an Operating Expense)
8.70%
7.75%
8.75%
8.75%
11.00%
10.50%
16.00%
12.50%
Office -100,000 - 199,999 S.F.
Class A
Class B
Class C
Class D
9.50%
8.00%
10.25%
9.00%
11.80%
10.50%
17.00%
12.50%
Office -50,000 to 99,999 S.F.
Class A
Class B
Class C
Class D
9.50%
7.75%
10.25%
9.00%
11.80%
10.00%
17.00%
12.50%
Office -49,999 S.F. or Less
Class A
Class B
Class C
Class D
8.75%
7.75%
8.75%
8.75%
11.00%
9.25%
16.00%
11.50%
Industrial
8.50%
8.25%
9.75%
9.00%
11.00%
10.00%
15.00%
14.50%
Retail-Regional Malls
Class A
Class B
Class C
Class D
7.60%
7.25%
8.60%
8.00%
9.75%
9.50%
15.00%
13.75%
Retail-C ommunity/Pow er Centers
Class A
Class B
Class C
Class D
8.60%
7.75%
9.35%
8.50%
10.25%
9.50%
14.50%
14.25%
Retail-Neighborhood Centers
Class A
Class B
Class C
Class D
8.35%
8.00%
9.15%
9.50%
11.15%
10.75%
14.00%
14.50%
Retail-Unanchored Strip Centers
Class A
Class B
Class C
Class D
9.10%
9.00%
9.10%
9.50%
11.25%
11.00%
13.50%
13.00%
Retail-Single Tenant/Net Leased
Class A
Class B
Class C
Class D
7.60%
6.75%
n/a
8.00%
n/a
9.50%
n/a
11.00%
Class A
Class B
Class C
Class D
Lodging-Full Service
Class A
Class B
Class C
Class D
Lodging-Limited/Select/Extended Stay
Class A
(With Reserves as an Operating Expense)
9.50%
8.00%
10.00%
9.00%
11.50%
9.50%
n/a
12.50%
(With Reserves as an Operating Expense)
10.5-11.0%
8.50%
59
ADDENDUM
Glossary ............................................................................................................................. A
Certification ........................................................................................................................B
General Assumptions and Limiting Conditions For a Consulting Assignment..................C
Professional Qualifications................................................................................................ D
57
GLOSSARY
A
Assessed Value: Assessed value applies in ad valorem taxation
and refers to the value of a property according to the tax rolls.
Assessed value may not conform to market value, but it is usually
calculated in relation to a market value base. 1
Capital Expenditure: Investments of cash or the creation of
liability to acquire or improve an asset, e.g., land, buildings,
building additions, site improvements, machinery, equipment; as
distinguished from cash outflows for expense items that are
normally considered part of the current period’s operations. 2
Cash Equivalence: A price expressed in terms of cash, as
distinguished from a price expressed totally or partly in terms of
the face amounts of notes or other securities that cannot be sold at
their face amounts. Calculating the cash-equivalent price requires
an appraiser to compare transactions involving atypical financing
to transactions involving comparable properties financed at typical
market terms. 2
frame allowed for marketing the property rights is somewhat
limited, but the marketing effort is orderly and adequate. With
liquidation value, the time frame for marketing the property rights
is so severely limited that an adequate marketing program cannot
be implemented. (The Report of the Appraisal Institute Special
Task Force on Value Definitions qualifies exposure time in terms
of the three above-mentioned values.) See also marketing time. 2
Extraordinary Assumptions: An assumption, directly related to a
specific assignment, which, if found to be false, could alter the
appraiser’s opinion or conclusions. 3
Fair Market Share: The ratio of the submarket inventory over the
fair market share.
Fee Simple Estate: Absolute ownership unencumbered by any
other interest or estate, subject only to the limitations imposed by
the governmental powers of taxation, eminent domain, police
power, and escheat. 2
Cost Approach: A set of procedures through which a value
indication is derived for the fee simple interest in a property by
estimating the current cost to construct a reproduction of (or
replacement for) the existing structure, including an
entrepreneurial incentive, deducting depreciation from the total
cost, and adding the estimated land value. Adjustments may then
be made to the indicated fee simple value of the subject property to
reflect the value of the property interest being appraised. 2
Floor Area Ratio (FAR): The relationship between the aboveground floor area of a building, as described by the building code,
and the area of the plot on which it stands; in planning and zoning,
often expressed as a decimal, e.g., a ratio of 2.0 indicates that the
permissible floor area of a building is twice the total land area; also
called building-to-land ratio. 2
Credible: worthy of belief 3
Going-Concern Value: The market value of all tangible and
intangible assets of an established and operating business with an
indefinite life, as if sold in aggregate. 1
Deferred Maintenance: Curable, physical deterioration that
should be corrected immediately, although work has not
commenced; denotes the need for immediate expenditures, but
does not necessarily suggest inadequate maintenance in the past. 2
Economic Life: The period over which improvements to real
property contribute to property value. 2
Effective Date: The date at which the analyses, opinions, and
advice in an appraisal, review, or consulting service apply.
(USPAP, 2002 ed.) 2
Gross Building Area (GBA): The total floor area of a building,
including below-grade space but excluding unenclosed areas,
measured from the exterior of the walls. Gross building area for
office buildings is computed by measuring to the outside finished
surface of permanent outer building walls without any deductions.
All enclosed floors of the building including basements,
mechanical equipment floors, penthouses, and the like are included
in the measurement. Parking spaces and parking garages are
excluded. See also area. 2
Effective Gross Income Multiplier (EGIM): The ratio between
the sale price (or value) of a property and its effective gross
income; a single year's EGI expectancy or an annual average of
several years' EGI expectancies (EGIM = V/EGI). 2
Highest and Best Use: The reasonably probable and legal use of
vacant land or an improved property, which is physically possible,
appropriately supported, financially feasible, and that results in the
highest value. The four criteria the highest and best use must meet
are legal permissibility, physical possibility, financial feasibility,
and maximum productivity. 2
Effective Rent: The rental rate net of financial concessions such as
periods of no rent during the lease term; may be calculated on a
discounted basis, reflecting the time value of money, or on a
simple, straight-line basis. 2
Hypothetical Condition: That which is contrary to what exists but
is supposed for the purpose of analysis. 3
Exposure Time:
1. The time a property remains on the market.
2. The estimated length of time the property interest being
appraised would have been offered on the market prior to the
hypothetical consummation of a sale at market value on the
effective date of the appraisal; a retrospective estimate based on an
analysis of past events assuming a competitive and open market.
Exposure time is always presumed to occur prior to the effective
date of the appraisal. The overall concept of reasonable exposure
encompasses not only adequate, sufficient and reasonable time but
also adequate, sufficient and reasonable effort. Exposure time is
different for various types of real estate and value ranges and under
various market conditions. (Appraisal Standards Board of The
Appraisal Foundation, Statement on Appraisal Standards No. 6,
"Reasonable Exposure Time in Real Property and Personal
Property Market Value Opinions")
Market value estimates imply that an adequate marketing effort
and reasonable time for exposure occurred prior to the effective
date of the appraisal. In the case of disposition value, the time
Income Capitalization Approach: A set of procedures through
which an appraiser derives a value indication for an incomeproducing property by converting its anticipated benefits (cash
flows and reversion) into property value. This conversion can be
accomplished in two ways. One year's income expectancy can be
capitalized at a market-derived capitalization rate or at a
capitalization rate that reflects a specified income pattern, return on
investment, and change in the value of the investment.
Alternatively, the annual cash flows for the holding period and the
reversion can be discounted at a specified yield rate. 2
Inspection of Property: An inspection is not required by USPAP,
but one is often conducted. The extent of the inspection process is
an aspect of the scope of work. An inspection conducted by an
appraiser is usually not the equivalent of an inspection by an
inspection professional (e.g., a structural engineer, al licensed
home inspector). An appraiser’s observations must, at the
minimum, be thorough enough to properly develop the appraisal
and adequately report the relevant characteristics. Regardless of
how the information is gathered, it must be sufficient for the
development of relevant analysis, such as the highest and best use,
the application of the approaches, etc. The extent of the inspection
process must be disclosed in the appraisal report.
Insurable Value: Value of property for insurance purposes. Based
on the value of the property, less indestructible parts (land) for fire
insurance. For title insurance purposes, the sales price (market
value) is used. 4
Intended Use: The use or uses of an appraiser’s reported
appraisal, appraisal review, or appraisal consulting assignment
opinions and conclusions, as identified by the appraiser based on
communication with the client at the time of the assignment. 3
Intended User: The client and any other party as identified, by
name or type, as users of the appraisal, appraisal review, or
appraisal consulting report by the appraiser on the basis of
communications with the client at the time of the assignment. 3
Internal Rate of Return (“IRR”): The annualized yield rate or
rate of return on capital that is generated or capable of being
generated within an investment or portfolio over a period of
ownership. The IRR is the rate of discount that makes the net
present value of the investment equal to zero. The IRR discounts
all returns from the investment, including returns from its
reversion, to equal the original capital outlay. This rate is similar to
the equity yield rate. As a measure of investment performance, the
IRR is the rate of discount that produces a profitability index of
one and a net present value of zero. It may be used to measure
profitability after income taxes, i.e., the after-tax equity yield rate.
See also equity yield rate; financial management rate of return
(FMRR); modified internal rate of return (MIRR); yield rate (Y). 2
Investment Value: The specific value of an investment to a
particular investor or class of investors based on individual
investment requirements; distinguished from market value, which
is impersonal and detached. See also market value. 2
Leasehold Interest: The interest held by the lessee (the tenant or
renter) through a lease transferring the rights of use and occupancy
for a stated term under certain conditions. See also negative
leasehold; positive leasehold.2
Leased Fee Interest: An ownership interest held by a landlord
with the rights of use and occupancy conveyed by lease to others.
The rights of the lessor (the leased fee owner) and the lessee are
specified by contract terms contained within the lease. 2
Load Factor: The amount added to usable area to calculate the
rentable area. It is also referred to as a “rentable add-on factor”
which, according to BOMA, “is computed by dividing the
difference between the usable square footage and rentable square
footage by the amount of the usable area. Convert the figure into a
percentage by multiplying by 100”.
Market Rent: The rental income that a property would most
probably command in the open market; indicated by the current
rents paid and asked for comparable space as of the date of the
appraisal. 2
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
and knowledgeably, and assuming the price is not affected by
undue stimulus. Implicit in this definition is the consummation of a
sale as of a specified date and the passing of title from seller to
buyer under conditions whereby:
(1)
Buyer and seller are typically motivated;
(2)
Both parties are well informed or well advised,
and acting in what they consider their own best
interests;
(3)
A reasonable time is allowed for exposure in the
open market;
(4)
Payment is made in terms of cash in U.S. dollars
or in terms of financial arrangements comparable
thereto; and
(5)
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." 5
Market Value "As If Complete" On The Appraisal Date:
Market value as if complete on the effective date of the appraisal is
an estimate of the market value of a property with all construction,
conversion, or rehabilitation hypothetically completed, or under
other specified hypothetical conditions as of the date of the
appraisal. With regard to properties wherein anticipated market
conditions indicate that stabilized occupancy is not likely as of the
date of completion, this estimate of value should reflect the market
value of the property as if complete and prepared for occupancy by
tenants.
Market Value "As Is" On The Appraisal Date: Value As Is The value of specific ownership rights to an identified parcel of
real estate as of the effective date of the appraisal; relates to what
physically exists and is legally permissible and excludes all
assumptions concerning hypothetical market conditions or possible
rezoning. See also effective date; prospective value opinion. 2
Market Value of the Total Assets of the Business: The market
value of the total assets of the business is the market value of all of
the tangible and intangible assets of a business as if sold in
aggregate as a going concern. This assumes that the business is
expected to continue operations well into the future. 6
Marketing Time:
1. The time it takes an interest in real property to sell on the
market sub-sequent to the date of an appraisal.
2. Reasonable marketing time is an estimate of the amount of time
it might take to sell an interest in real property at its estimated
market value during the period immediately after the effective date
of the appraisal; the anticipated time required to expose the
property to a pool of prospective purchasers and to allow
appropriate time for negotiation, the exercise of due diligence, and
the consummation of a sale at a price supportable by concurrent
market conditions. Marketing time differs from exposure time,
which is always presumed to precede the effective date of the
appraisal. (Advisory Opinion 7 of the Appraisal Standards Board
of The Appraisal Foundation and Statement on Appraisal
Standards No. 6, "Reasonable Exposure Time in Real Property and
Personal Property Market Value Opinions" address the
determination of reasonable exposure and marketing time.) See
also exposure time. 2
Net Lease: Generally a lease in which the tenant pays for utilities,
janitorial services, and either property taxes or insurance, and the
landlord pays for maintenance, repairs, and the property taxes or
insurance not paid by the tenant. Sometimes used synonymously
with single net lease but better stated as a partial net lease to
eliminate confusion. Also called single net lease; modified gross
lease, single net lease; modified gross lease. See also lease. 2
Net Rentable Area (NRA): 1) The area on which rent is
computed. 2) The Rentable Area of a floor shall be computed by
measuring to the inside finished surface of the dominant portion of
the permanent outer building walls, excluding any major vertical
penetrations of the floor. No deductions shall be made for columns
and projections necessary to the building. Include space such as
mechanical room, janitorial room, restrooms, and lobby of the
floor. 7
Penetration Ratio (Rate): The rate at which stores obtain sales
from within a trade area or sector relative to the number of
potential sales generated; usually applied to existing facilities. 2
Principle of Substitution: The appraisal principle that states that
when several similar or commensurate commodities, goods, or
services are available, the one with the lowest price will attract the
greatest demand and widest distribution. This is the primary
principle upon which the cost and sales comparison approaches are
based. 2
Prospective value opinion. A forecast of the value expected at a
specified future date. A prospective value opinion is most
frequently sought in connection with real estate projects that are
proposed, under construction, or under conversion to a new use, or
those that have not achieved sellout or a stabilized level of longterm occupancy at the time the appraisal is written. See also
effective date; value as is. 2
Reconciliation:
1. The last phase of any valuation assignment in which two or
more value indications derived from market data are resolved into
a final value opinion, which may be either a final range of value or
a single point estimate.
2. In the sales comparison approach, reconciliation may involve
two levels of analysis: 1) derivation of a value indication from the
adjusted prices of two or more comparable sales expressed in the
same unit of comparison and 2) derivation of a value indication
from the adjusted prices of two or more comparables expressed in
different units of comparison. See also point estimate; range of
value. 2
Remaining Economic Life: The estimated period during which
improvements will continue to contribute to property value; an
estimate of the number of years remaining in the economic life of
the structure or structural components as of the date to the
appraisal. 2
Replacement Cost: The estimated cost to construct, at current
prices as of the effective appraisal date, a building with utility
equivalent to the building being appraised, using modern materials
and current standards, design, and layout. 2
Retrospective Value Estimate: An estimate of value that is likely
to have applied as of a specified historic date. A retrospective
value estimate is most frequently sought in conjunction with
appraisals for estate tax, condemnation, inheritance tax, and similar
purposes.
Sales Comparison Approach: A set of procedures in which a
value indication is derived by comparing the property being
appraised to similar properties that have been sold recently, then
applying appropriate units of comparison and making adjustments
to the sale prices of the comparables based on the elements of
comparison. The sales comparison approach may be used to value
improved properties, vacant land, or land being considered as
though vacant; it is the most common and preferred method of land
valuation when an adequate supply of comparable sales are
available. 2
Scope of Work: The amount and type of information researched
and the analysis applied in an assignment. Scope of work includes,
but is not limited to, the following:
1. The degree to which the property is inspected or identified;
2. The extent of research into physical or economic factors that
could affect the property;
3. The extent of data research; and
4. The type and extent of analysis applied to arrive at opinions or
conclusions. 2
Self-Contained Appraisal Report: A written appraisal report
prepared under Standards Rule 2-2(a) of the Uniform Standards of
Professional Appraisal Practice (USPAP, 2002 ed.). A selfcontained appraisal report sets forth the data considered, the
appraisal procedures followed, and the reasoning employed in the
appraisal, addressing each item in the depth and detail required by
its significance to the appraisal and providing sufficient
information so that the client and the users of the report will
understand the appraisal and not be misled or confused. 2
Stabilized value: A value opinion that excludes from
consideration any abnormal relationship between supply and
demand such as is experienced in boom periods when cost and sale
price may exceed the long-term value, or during periods of
depression, when cost and sale price may fall short of long-term
value. It is also a value opinion that excludes from consideration
any transitory condition that may cause excessive construction
costs, e.g., a premium paid due to a temporary shortage of supply.
Total Assets of a Business: Total assets of a business is defined
by the Appraisal Institute as “the tangible property (real property
and personal property, including inventory and furniture, fixtures
and equipment) and intangible property (cash, workforce,
contracts, name, patents, copyrights, and other residual intangible
assets, to include capitalized economic profit).” 2
Total Intangible Assets: Total intangible assets of a business is
defined by the Appraisal Institute as “all of the intangible assets
owned by a business (going concern), which can be further divided
into two categories for valuation purposed: identified intangible
assets and residual intangible asset.” 2
Use Value:
1. In economics, the attribution of value to goods and services
based upon their usefulness to those who consume them.
2. In real estate appraisal, the value a specific property has for a
specific use; may be the highest and best use of the property or
some other use specified as a condition of the appraisal; may be
used where legislation has been enacted to preserve farmland,
timberland, or other open space land on urban fringes. See also
exchange value; value in use. 2
1
Appraisal Institute, The Appraisal of Real Estate, 12th ed.
(Chicago: Appraisal Institute 2001).
2
Appraisal Institute, The Dictionary of Real Estate Appraisal, 4th
ed. (Chicago: Appraisal Institute 2002).
3
”Uniform Standards of Professional Practice” (The Appraisal
Foundation, 2006 Edition).
4
1990 BOMA Experience Exchange Report, Income/Expense
Analysis for Office Buildings (Building Owners and Managers
Association, 1990).
5
* This definition is from regulations published by federal
regulatory agencies pursuant to Title XI of the Financial
Institutions Reform, Recovery, and Enforcement Act (FIRREA) of
1989 between July 5, 1990, and August 24, 1990, by the Federal
Reserve System (FRS), National Credit Union Administration
(NCUA), Federal Deposit Insurance Corporation (FDIC), the
Office of Thrift Supervision (OTS), and the Office of Comptroller
of the Currency (OCC). This definition is also referenced in
regulations jointly published by the OCC, OTS, FRS, and FDIC on
June 7, 1994, and in the Interagency Appraisal and Evaluation
Guidelines, dated October 27, 1994.
6
This definition is taken from “Allocation of Business Assets Into
Tangible and Intangible Components: A New Lexicon,” Journal of
Real Estate Appraisal, January 2002, Volume LXX,
Number 1. This terminology is to replace former phrases such as:
value of the going concern.
7
Financial Publishing Company, The Real Estate Dictionary, 7th
ed. (LandAmerica, 2001).
CERTIFICATION
B
CERTIFICATION OF THE APPRAISER
We certify that, to the best of my knowledge and belief:

The statements of fact contained in this report are true and correct.

The reported analyses, opinions, and conclusions are limited only by the reported assumptions and limiting
conditions and is our personal, impartial, and unbiased professional analyses, opinions, and conclusions.

We have no present or prospective interest in the property that is the subject of this report and no personal
interest with respect to the parties involved.

We have no bias with respect to the property that is the subject of this report or to the parties involved with
this assignment.

Our engagement in this assignment was not contingent upon developing or reporting predetermined results.

Our compensation for completing this assignment is not contingent upon the development or reporting of a
predetermined value or direction in value that favors the cause of the client, the amount of the value opinion,
the attainment of a stipulated result, or the occurrence of a subsequent event directly related to the intended
use of this appraisal.

Our analyses, opinions, and conclusions were developed, and this report has been prepared, in conformity
with the Uniform Standards of Professional Appraisal Practice.

Luten L. Teate, MAI and John W. Cherry, Jr. MAI, CRE have not made a personal inspection of the sale
comparables used in this analysis.

The reported analyses, opinions, and conclusions were developed, and this report has been prepared, in
conformity with the requirements of the Code of Professional Ethics and the Standards of Professional
Appraisal Practice of the Appraisal Institute, the minimum appraisal standards cited in section 323.4 of Title
XI of FIRREA.

The use of this report is subject to the requirements of the Appraisal Institute relating to review by its duly
authorized representatives.

As of the date of this report, Luten L., MAI and John W. Cherry, Jr. MAI, CRE have completed the
requirements of the continuing education program of the Appraisal Institute. Both appraisers have fulfilled
the certification requirements of the State of Tennessee.
Respectfully submitted,
LandAmerica Valuation Corporation
By:
Luten L. Teate, MAI
Senior Appraiser
State Certified General Appraiser # 00001080
By:
John W. Cherry, Jr. MAI, CRE
State Certified General Appraiser # 1070
GENERAL ASSUMPTIONS AND LIMITING CONDITIONS FOR A
CONSULTING ASSIGNMENT
C
GENERAL ASSUMPTIONS AND LIMITING CONDITIONS FOR A CONSULTING ASSIGNMENT
The following Standard Conditions apply to real estate consulting and market analysis engagements (“analysis”)
by LandAmerica Valuation Corporation ("LandAmerica"). Special Conditions are added as required.
Report Content:
Analyses are performed and written reports are prepared in accordance with the Uniform Standards of Professional
Appraisal Practice of the Appraisal Foundation and with the Appraisal Institute's Standards of Professional
Appraisal Practice and Code of Professional Ethics.
The analysis assumes market conditions as observed as of the current date of our market research stated in the
letter of transmittal. These market conditions are believed to be correct; however, the analysts assume no liability
should market conditions materially change because of unusual or unforeseen circumstances.
No opinion is rendered as to property title, which is assumed to be good and marketable. Unless otherwise stated,
no consideration is given to liens or encumbrances against the property. It is assumed that legal, engineering, or
other professional advice, as may be required, has been or will be obtained from professional sources and that the
report will not be used for guidance in legal or technical matters such as, but not limited to, the existence of
encroachments, easements or other discrepancies affecting the legal description of the property. It is assumed that
there are no concealed or dubious conditions of the subsoil or subsurface waters including water table and flood
plain, unless otherwise noted. We further assume there are no regulations of any government entity to control or
restrict the use of the property unless specifically referred to in the report. It is assumed that the property will not
operate in violation of any applicable government regulations, codes, ordinances or statutes.
This report is not intended to be an engineering report. We are not qualified as structural or environmental
engineers; therefore we are not qualified to judge the structural or environmental integrity of the improvements, if
any. Consequently, no warranty or representations are made nor any liability assumed for the structural soundness,
quality, adequacy or capacities of said improvements and utility services, including the construction materials,
particularly the roof, foundations, and equipment, including the HVAC systems, if applicable. Should there be any
question concerning same, it is strongly recommended that an engineering, construction and/or environmental
inspection be obtained. We will call to your attention any apparent defects or material adverse conditions which
come to our attention.
In the absence of competent technical advice to the contrary, it is assumed that the property being analyzed is not
adversely affected by concealed or unapparent hazards such as, but not limited to asbestos, hazardous or
contaminated substances, toxic waste or radioactivity.
Information furnished by others is presumed to be reliable, and where so specified in the report, has been verified;
but no responsibility, whether legal or otherwise, is assumed for its accuracy, and it cannot be guaranteed as being
certain. No single item of information was completely relied upon to the exclusion of other information.
Analysis reports may contain estimates of future financial performance, estimates or opinions that represent the
analyst's view of reasonable expectations at a particular point in time, but such information, estimates or opinions
are not offered as predictions or as assurances that a particular level of income or profit will be achieved, that
events will occur, or that a particular price will be offered or accepted. Actual results achieved during the period
covered by our prospective financial analyses will vary from those described in our report, and the variations may
be material.
Any proposed construction of rehabilitation referred to in the analysis is assumed to be completed within a
reasonable time and in a workmanlike manner according to or exceeding currently accepted standards of design
and methods of construction.
It should be specifically noted by any prospective mortgagee that the analysis assumes that the property will be
competently managed, leased, and maintained by financially sound owners over the expected period of ownership.
This engagement, unless otherwise noted, does not entail an evaluation of management's or owner's effectiveness,
nor are we responsible for future marketing efforts and other management or ownership actions upon which actual
results will depend.
The Americans with Disabilities Act ("ADA") became effective January 26, 1992. LandAmerica has not made a
specific compliance survey and analysis of this property to determine whether or not it is in conformity with the
various detailed requirements of the ADA. It is possible that a compliance survey of the property, together with a
detailed analysis of the requirements of the ADA, could reveal that the property is not in compliance with one or
more of the requirements of the Act. If so, this fact could have a negative effect upon the value of the property.
Since LandAmerica has no direct evidence relating to this issue, LandAmerica did not consider how possible noncompliance with the requirements of ADA would impact the value of the property being analyzed.
Use of the Report:
The analysis applies only to the property or market area described and for the purpose so stated and should not be
used for any other purpose. The report and estimates of future financial performance included therein, are intended
for the information of the person or persons to whom they are addressed, solely for the purposes stated therein, and
should not be relied upon for any other purpose. The addressee shall not distribute the report to third parties
without prior permission of LandAmerica. Before such permission shall be provided, the third party shall agree to
hold harmless relative to their use of the report. Neither our report, nor its contents, nor any reference to the
analysts or LandAmerica, may be included or quoted in any offering circular or registration statement, prospectus,
sales brochure, appraisal, loan or other agreement or document without our prior written permission. Permission
will be granted only upon meeting certain conditions. Generally, LandAmerica will not agree to the use of its
name as a "named expert" within the meaning of the Securities Act of 1933 and the Securities Act of 1934.
Neither the report nor any portions thereof (especially the identity of the analysts or LandAmerica) shall be
disseminated to the public through public relations media, news media, advertising media, sales media or any other
public means of communication without the prior written consent and approval of LandAmerica. The date(s) to
which the conclusions apply is set forth in the letter of transmittal and within the body of the report. The financial
analysis is based on the purchasing power of the United States dollar as of that date.
Terms of the Engagement:
Assignments are accepted with the understanding that there is no obligation to furnish services after completion of
the original assignment. If the need for subsequent service related to a specific assignment (e.g., testimony,
updates, conferences, reprint or copy service) is contemplated, special arrangements acceptable to LandAmerica
must be made in advance. The working papers for this engagement have been retained in our files and are
available for your reference.
Unless otherwise stated, no effort has been made to determine the possible effect, if any, on the subject property of
energy shortage or future federal, state or local legislation, including any environmental or ecological matters or
interpretations thereof.
We take no responsibility for any events, conditions or circumstances affecting the subject property or its value,
that take place subsequent to either the effective date of the analysis cited in the report or the date of our field
inspection, whichever occurs first.
PROFESSIONAL QUALIFICATIONS
D
Luten L. Teate, MAI
Profile
Mr. Teate entered the real estate business in
1977 as a title examiner for several Atlanta area
law firms. In 1979, he joined Couch &
Associates as a junior appraiser.
Couch & Associates was acquired by Cushman
& Wakefield in 1981 and Mr. Teate was an
appraiser until April, 2005. During that time,
Mr. Teate was a member Cushman &
Wakefield’s retail specialty group and the
regional mall sub-specialty group. Mr. Teate
joined LandAmerica Valuation Corporation as
an appraiser in April, 2005.
Experience
Appraisal and consulting assignments have
included shopping centers, regional malls, office
buildings, industrial buildings, vacant land and
other investments properties. Valuations have
been made of proposed, partially completed,
renovated, and existing properties.
Professional Affiliations
General Certified Appraiser
Georgia (No. CG001389)
Alabama (No. G00619)
Tennessee (No. 00001080)
Member of the Appraisal Institute (MAI
Designation No. 7843)
Education
Emory University - B.A. (Economics), graduated
in 1970.
Georgia State University - various post graduate
real estate courses.
John W. Cherry, Jr., MAI, CRE
Professional Affiliations
MAI (#6010)
Appraisal Institute
Profile
John W. Cherry, Jr., MAI, CRE has
approximately 34 years of extensive
experience in real estate valuation and
investment analysis including a diversified
background in the valuation of real estate for
a wide range of applications including
market value appraisals, reviews, appraisal
support for both conventional and bond
financed properties, due diligence, and
specialized valuations including wholesale
trade marts, arenas and stadiums. These
activities have been conducted on behalf of
major financial institutions, pension funds,
government agencies, major corporations,
individual investors, and legal firms. The
types of properties appraised and
engagements include:
• Preparation of market value appraisals for
all types of real estate with a full range of
valuation objectives;
• Intensive experience in the valuation of
regional wholesale marts and regional
shopping malls;
• Market studies for existing or proposed
development projects;
• Investment analysis via lease analysis and
discounted cash flow techniques before
and after debt service;
• Mixed-use land and subdivision
development valuation; and
• Special purpose properties.
Education
Bachelor of Business Administration
Oglethorpe University
Atlanta, Georgia
CRE
The American Society of Real Estate Counselors
Certified General Real Property Appraiser
State of Georgia
License # 001233
State of Florida
License # RZ0002230
State of South Carolina
License # 5531
State of Tennessee
License # 1070
State of Alabama
License # G00673
State of Mississippi
License # GA 845
Affiliate Member
Atlanta Board of Realtors
Member
National Association of Industrial & Office Properties
Professional History
Chief Appraiser
LandAmerica Valuation Corporation
Director
Southeast Region Practice Leader
Real Estate Advisory Services
PricewaterhouseCoopers LLP
Manager
Laventhol & Horwath
Vice President-Valuation Group
Coldwell Banker
Mortgage Officer
C & S National Bank

capitalization rate analysis - the Shelby County Assessor of Property

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