It's been heading towards a crisis ever since Covid. Depending on when the Fed lowers rates, the end result will be pushed off for a few more years, but you're going to see lots of buildings given up on. My personal belief is that there's a lot of negotiation behind the scenes as both banks and property owners work out deals to make it seem not as bad. There's also the issue of cities like NYC who rely heavily on office building property taxes for funding.
I've heard it said that banks/property owners aren't super excited to renegotiate to something more reasonable, because having something sitting there vacant unused lets them keep the pretense about the property's value. If they start cutting rents, they risk having to report the loss in expected value, and that would be so horrible that they'd rather just let the property sit.
>If they start cutting rents, they risk having to report the loss in expected value, and that would be so horrible that they'd rather just let the property sit.
This is also why you'll see deals like X months free, because that's a way to say "Look, they're paying the requested rate!" but in reality they're earning less money per month due to the free months. This goes for residential real estate like apartments as well.
Any appraisal would base NOI on Net Effective Rent not Face Rates, so asset book values would not really be affected by shifting more shortfall into rent abatements or tenant improvement allowances.
This is inaccurate. I am in the industry. Appraisals are 100% based on face rates rather than NER and it is common to “buy up” the face rate by offering higher tenant inducements (cash) and free rent. It makes sense too from the bank’s perspective because the loan will be serviced over the life of the loan by the face rate, not the NER. So if the landowner pays up front to have higher cash flows in later years, the bank is fine with that.
There are regional differences in methodology but here in Canada, with institutional clients, we model rent abatements, TIs, and LCs. So no, it is not inaccurate. If you’re a lender that only cares about NOI and not a pension fund establishing a periodic value, you are free to ignore the adjustments below the line. But they are there in any Market Value appraisal.
I am in Canada too. If you are working for a pension fund doing appraisals for their own assets that’s totally different. I am referring to appraisals for lending decisions.
I have pension fund lenders on current projects and past projects and they absolutely did not care about (or even inquire about) incentive packages affecting NER so long as the stabilized NOI meets the debt servicing ratios.
I have dozens and dozens of market value appraisals for projects I’ve done and projects I’ve looked at doing (vendor provided) by appraisers all across the country and I have never, ever seen one that takes into account inducement packages.
Like I say, if you’re a lender that only gives a shit about stabilized NOI, that’s A-Ok. But if I’m signing an appraisal that asserts a Market Value with no extra assumptions or conditions, that market value will account for your free rent and TIs.
Can I ask out of curiosity, are you located in the maritimes?
No, I am located in BC now (Cranbrook) but primary assets in Ontario (link in profile) and working on a project in Alberta at the moment. I did live out near Halifax for a good chunk of Covid and had offers in on projects in Halifax and Sydney. Happy I didn’t get the Halifax projects but still sad I missed the Sydney project.
Nice. I'm also in B.C. now (Vancouver) but spent most of my career so far in Calgary.
I realize the source of confusion here — I said NOI is based on NERs in my first comment when I should have said market value. NOI would indeed typically be stabilized at market face rents, and then we would apply below the line adjustments for off-market rents, abatements, leasing/capital costs, etc.
I believe they bought residential MBSs, which is one of the reasons why mortgage interest rates went so low. They may have bought commercial MBSs, but if they did I don't remember reading about it.
