Assessing Risk to Commercial Properties

August 4, 2020

INTRODUCTION

In the coming months, as many in the commercial real estate space will be making challenging decisions due to the effects of COVID-19, it will become increasingly necessary to assess the risk inherent in them as accurately as possible. In this article, we’ll first discuss some general guidelines for property risk assessment then cover some broad market trends especially relevant to California. Finally, we’ll detail how to obtain a Valbridge Property Risk Assessment Report for a specific property, and indicate how you can obtain a free sample report.

HOW TO ASSESS RISK ON COMMERCIAL PROPERTIES

While general market trends are essential to monitor and understand, it is also true that each sector of the commercial real estate economy will perform differently. Understanding the micro-level realities unique to a property or a limited portfolio will be critical to making wise decisions on specific sites, investments, and development opportunities.

(For more on how various sectors are performing, and the variability inherent across CRE during 2020, please see our Special Report on the Impact of COVID-19 on Commerical Real Estate from June 2020).

When undertaking a good risk assessment analysis, it will be important to consider factors such as location, physical characteristics, economic occupancy, and the overall property sector.

It is important also to physically inspect a building, to obtain a property level view of current conditions, and to answer questions like:

  • Is there true vacancy with empty space?
  • Has there been major deferred maintenance?
  • Do any residual effects exist from changing city or county use permissions, protests, etc?

These site-specific features should be understood alongside a Commercial Location Score (CLS), created by Moody’s Analytics, which takes into consideration six factors including:

  • Economic prosperity
  • Business vitality
  • Spatial demand
  • Transportation
  • Amenities
  • Area safety

Understanding the impact of these factors individually and in the aggregate helps business owners and investors determine the locational strength of a given property and/or area. A commercial location score is useful in that it quantifies “qualitative” characteristics through a standardized approach and score, utilizing both traditional and non- traditional data sets. CLS scoring provides the following:

  1. A nominal score (400-1,000) and a breakout of the nominal scores for each of the six categories;
  2. A percentile rank for the composite score and each category relative to the specific market; and
  3. A breakout of the component weights used to compute the composite score.

CALIFORNIA MARKET TRENDS

As mentioned above, a good understanding of both overall market trends and trends specific to a property sector and submarket will be instrumental in property assessing risk. Statistical forecast analysis has as its basis the proposition that past statistical relationships hold into the future, and knowledge of those correlations, current data, and perhaps some assumptions about data not yet known, lead to the forecast.

UCLA Anderson Forecast – the leading independent economic forecast of both the U.S. and California economies for over 65 years – has very recently released a Commercial Real Estate Survey and Index to better predict future California commercial rental and vacancy rates (sponsored by Allen Matkins). This report, which you can read in full here, surveyed supply-side participants (e.g. commercial developers and financiers of commercial development) for insights into their markets in order to provide a measure of their view of current and future conditions. The results are helpful in our process of assessing risk, and provide some of the most up-to-date data available for particular market sectors in California.

It’s worth pulling out a few sector by sector highlights from this report to help add some context to risk assessments you might undertake or order in the coming weeks and months.

For OFFICE MARKETS, sentiments were generally gloomy. As in 2008, it is likely that we will see an ongoing decrease in new office construction over the coming three years. From the UCLA report:

Although half of the Bay Area and Southern California panelists said their plans for the coming 12 months were unaffected by the pandemic, one-third are ramping back development by more than 15 percent from their previous plans. Overall, 75 percent of panelists expressed some stress with current tenant leases. For the one-third that will engage in some new development, the panelists in each market believed that land, building materials, and labor costs would be more favorable. Given the uncertainty about office space demand, these responses seem reasonable and indicate growth in development beginning in late 2021 and a slow return to pre-recession levels.

The outlook for RETAIL MARKETS is probably the worst of any sector, for reasons we outlined in our previous Impact report. UCLA’s report agrees with those root causes, and predicts that:

the pessimism expressed…is an extension of the trends from the past three years. The current view is that retail properties will be generating significantly lower, if any, returns in 2023 compared to the middle of 2020. In the Bay Area and Southern California, two-thirds of panelists will not develop any new properties in the coming 12 months. Approximately the same percentage expect difficulty with current leases and expect plummeting property values.

However, opportunities do exist: in Southern California specifically, about a third of those surveyed planned to undertake new retail development or re-development projects this year.

California’s housing shortage is not news, and the impact of the pandemic on MULTI-FAMILY MARKETS will likely intensify the demand for more housing that has been a constant in the market for some years now. UCLA’s report predicts a fairly quick turnaround in this sector once the acute phase of the pandemic is over, noting that

As the economy grows, the demand for housing in the Bay Area and Southern California will grow alongside it. Though the UCLA Anderson Forecast is looking at a 30-month recovery in the state, and there remains a great deal of uncertainty with regard to the current public health crisis, the market for multi-family housing remaining robust seems likely.

“It is hard to envision a scenario in which COVID-19 and its fallout could remedy the underlying housing affordability issues that California faced coming into 2020. In light of that ongoing concern, we expect demand for multi-family housing to continue to be high.”

INDUSTRIAL MARKETS, like multi-family, are likely to fare well, having experienced consistently high occupancy and rental rate growth over the past several years. While a recalibration of the market is predicted, there is good potential for positive outcomes here as well, notably:

If the demand for warehouse space and the stock of warehouses are increasing at about the same rate as projected, then 2023 will see a mild erosion of rental rates when adjusted for inflation, and there remains the possibility of some erosion in occupancy. However, that does not mean that industrial space markets will be depressed, rather that they will not be as imbalanced as in recent years.

Taken as a whole, the predictions and forecasts for the market make one thing clear: while the overall impact of the pandemic will be felt for some months to come, opportunities are certainly available to smart and savvy players, which is why this is certainly a major takeaway:

Assessing site-specific risk properly in such a volatile market is even more important than ever before. Obtaining accurate, up-to-date, and quantifiable information, and combining it with larger market trends, will help you make informed decisions in the coming months.

While you can certainly assess risk yourself, it often makes sense to go with an expert in valuation like Valbridge Property Advisors – our market specific knowledge combined with a rigorous approach to risk assessment makes our reports particularly valuable during this difficult time.

HOW TO OBTAIN A RISK ASSESSMENT REPORT FROM VALBRIDGE

Valbridge Property Risk Assessments combine detailed market analyses, site inspections, and the Moody’s Analytics Commercial Location Score. The resulting data is used to develop a unique, site-specific Valbridge Risk Score. This score can be used to make informed, real-time decisions regarding CRE investments, using data-driven technology to analyze variables that affect value.

You can obtain a sample of a risk assessment report or order an assessment for a specific property by contacting our offices; one of our local market experts will be in touch with you right away to discuss next steps.

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Valbridge Property Advisors have the largest independent commercial property valuation and advisory services firms in the U.S., with 200 MAI- designated appraisers, over 80 office locations and more than 675 staff across the nation. Valbridge provides independent appraisal services consistent with the highest industry standards of practice. Each Valbridge office is led by an appraiser who holds the MAI designation of the Appraisal Institute.

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