Fundamental Elements

As the covid pandemic plays bull in our china shop economy, anyone underwriting real estate values and risk would be wise to go back to basics.

Yesterday, the latest issue of “Commercial Investment Real Estate” (the magazine of the CCIM Institute) came to my mailbox – my real mailbox.  So, after sanitizing it, I sat down to read.  Its contents include a great article by Christopher H. Volk titled “10 Biases in Retail Investment”.  The author presents ten common cognitive biases that plague investors/underwriters in their analysis of retail real estate investment opportunities.  Some of the biases relate to misunderstanding structural differences between corporate bonds and net leases, but Volk points to five specifically labeled real estate cognitive biases that pertain to both private and publicly held assets:

  • “More highly valued real estate is always apt to deliver safer and assured returns.
  • Tenants having strong credit quality elevate real estate value, performance and safety.
  • The quality of real estate is evidenced by the yield (cap rate) at which it trades.
  • Differences in investment cap rates represent proportional risk differences.”


  • “Net asset value is an indicator of asset desirability and expected economic performance.”

Most of us have encountered these assertions in one form or another in offering memoranda or valuation reports.  Volk suggests these biases tend to come from loosely recalled or anecdotal experience – never supported by academic studies.

Obviously, rising tides float all the boats.  In good times, our biases are less likely to precipitate serious financial loss.  At low tide, though, hull wrecking shoals and spoil are more clearly revealed.  As we sort through the pandemic wrecked economy, we begin with few footholds.  Historic data, even recent historic data becomes much more unreliable.  This is particularly true in this downturn because we also face the prospect of significant, permanent behavioral modifications.

One beginning point we can latch onto is cost.  The replacement cost of a functional real estate asset represents the cost of production.  Yes, the hard parts remain – estimating site improvement costs, estimating profit, estimating depreciation from all causes and, of course, land value.  That’s why appraiser’s and underwriters rarely develop or rely on cost analysis in good times – too many areas that can be wrong or subjective or difficult to source.

But until a “post lockdown” set of sales and leases is completed, cost analysis has equal reliability with sales and income.

In estimating cost in our practice, we have always relied on Marshall Valuation Services Commercial Estimator Software.  To mark the moment, we took a stab at estimating the costs of typical commercial buildings that might be constructed in South Florida zip codes.  These prototypes are not actual projects.  Included in the portfolio are a suburban office building, a high-rise office tower (with structured parking), a distribution warehouse, a suburban apartment building, a limited service hotel and a full-service hotel (with structured parking).  The cost rank selected was above average.  Additions to the base cost were made for soft costs not included in the cost service and a 15% profit was added.  The delivered product is an estimate of the cost of the base structure without provision for site improvements or land value.  Hopefully, I’ll have energy for revisiting these numbers in future months.

cost summary snip

Stay safe.



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