The economic analysis process requires you to recognize both macroeconomic and microeconomic forces that influence property values. The general economic condition of the country affects prices to varying degrees. The presence of high inflation rates or economic recession has a significant impact upon real estate prices. Similarly, population movements and aging must be acknowledged when evaluating a potential acquisition. These trends set the regional background for economic activity in your area. Small projects require less detailed regional economic analysis than large ones. You must not ignore these factors when examining a property.
Following are some key factors to consider when valuing a property:
Local Trends
Local trends have a strong impact on improved real property. Real estate can be compared with agriculture in that productivity for both depends on locality. Peaches are not grown in Alaska, and major buildings are not constructed and managed in small communities. Although this may seem to be an oversimplification, a property that is subject to local problems, such as a high rate of unemployment, will suffer regardless of the state of the national economy. By assessing your local economy, you will begin to get a feel for whether your property will be valued at a favorable, comparable, or less-than-comparable price.
Growth Patterns
Cities generally grow according to the needs and desires of their population. Nevertheless, certain exceptions should be evaluated in any analysis. Natural and manmade impediments to growth are among these exceptions. These include mountains, rivers, lakes, railroad tracks, and major, limited-access highways. Another obstacle is the capacity to accommodate growth. Local authorities are prone to place moratoriums on building growth because of existing infrastructure problems, such as the unavailability of roads, natural gas, water, or sanitary systems. If your building is located in an area where growth is inhibited, either by natural conditions or by growth restrictions, this will affect the value of your property. Typically, economics is the principal factor determining growth. If there is a high level of employment, for example, an area will prosper. Through prosperity, the working public will enhance its lifestyle and seek improved housing. As this process continues, office buildings and retail locations that were previously ignored become valuable, while other locations that were once considered desirable may no longer even be considered viable. It is not possible to precisely predict where attractive locations will emerge. One key indicator, however, is the availability of executive housing.
Single-Family Homes and Apartments
For office or retail space to be attractive to prospective tenants or buyers, there must be an adequate supply of housing, both single- and multifamily. If you are attempting to put a value on a property in order to lease it at a competitive market rate, be sure to review available housing. Corporations seeking relocation, for example, will be concerned with the availability of housing.
Business Sector
You can determine the past growth of a city by pinpointing the locations of major business and retail areas and, thus, reasonably predict the locations and timing of the next generation of business and retail centers. Office and related business growth is highly dependent upon the availability of retail stores. The appeal of a building itself is not enough; area amenities are fundamental to the success of a building. If your building is in an area that is considered “up-and-coming” or “revitalized,” these are favorable conditions that will influence the economic valuation of your property.
Political Climate
As a trend factor, politics plays an important role in an area’s future. The growth of a city is tied directly to its attitude toward commerce and industry. If the attitude is favorable, as expressed by offering such specialized accommodations as property tax credits, commerce will be attracted. If, however, the city is opposed to growth, it will eventually stagnate financially. Your careful analysis should include a thorough understanding of local issues and attitudes.
Property Life Cycle
The economic analysis of any property requires an understanding of building life cycles and the remaining life of the property you are examining.
A property life cycle generally consists of four stages:
- development
- routine administration
- modernization/rehabilitation/conversion
- demolition
Development
Development analysis is based on identifying and evaluating the need for a particular property type and size. This type of analysis includes such items as an absorption study, a floor plate survey, a rent grid survey, and an area analysis. Because you are evaluating an already-existing property, this stage plays virtually no role in your assessment, unless you are attempting to make a determination of whether to add construction to the existing building. If you are attempting to add to the existing building, key factors to review include market need, availability of financing, availability of land, and level of risk.
Routine Administration
Routine administration of a property typically represents the longest single phase of the property life cycle. A rule of thumb is that building efficiency tends to follow ten-year cycles. During its first few years, a new structure is considered to be stabilized; it is performing the functions for which it was intended. In later years, the cost of maintaining the property rises as building components wear out. This cycle also generally exists during the years immediately following a major rehabilitation. Depending on where your building is in this part of the property life cycle and assuming the building has been properly managed, the economic value should be in your favor.
Modernization/Rehabilitation/Conversion
As wear and tear begins to take its toll on buildings, daily repairs will no longer keep pace with deterioration of the structure or with competing buildings. Each year another generation of buildings is constructed with more positive marketing features. Remember to be honest in your assessment of the state of your property. A building’s condition will not necessarily impact the economic assessment in a negative fashion. A deteriorating building in a “hot” neighborhood can often have greater value than a high-tech building in an area of no growth.
Demolition
Unfortunately, there will come a time when almost every building will outlive its usefulness. Perhaps you are attempting to assess the value of a property to decide whether it is more economically feasible to tear the building down and start from scratch. Time, safety, location, and purpose all play a part in determining the fate of a structure. The decision to tear down a building may not be an easy one. There may be previously unrecognized demolition costs; for example, the presence of asbestos or other hazardous materials will require special procedures to remove. You must investigate all possible alternatives before committing to demolition.
Although the information provided herein is by no means all-inclusive, it should give you a solid basis on which to begin your economic feasibility analysis. The information provided in this article is adapted from BOMI Institute’s Real Estate Investment and Finance course book, revised and updated for 2004.
