Appraisers dig for data to determine value.
demand for high-quality commercial real estate in primary and many secondary
markets has been gaining strength during the past 12 to 18 months. As the availability
of good product in primary markets has diminished, some potential buyers are
considering alternatives in smaller secondary and even some tertiary markets.
While major investors will not consider these areas, there are outside
investors that want higher returns and understand the risks of buying in these
real estate becomes more difficult in secondary and tertiary markets where the
lack of recent, arm’s-length comparable data is a major hurdle. Other concerns
in small markets are population, job, and income growth over the holding
period. The lack of barriers to entry is often an issue based on the
availability and relatively low cost of land. Finally, the sophistication and
motivations of buyers and owners in small secondary and tertiary markets can
lead to varying sales prices.
a result of these factors, valuing complex properties in primary or large
secondary markets is often easier than valuing simple properties in smaller
markets, mainly because of the availability of market data, which includes
more-consistent sales and rent comparables and investor expectations.
there are a number of ways that a resourceful appraiser can gather the required
data and attain a market value for a property in a small market. Let’s look at
some of the differences between primary markets and secondary markets and
several ways to value properties in secondary and tertiary markets.
Secondary Markets Move Up
past decade, the lines between primary and secondary markets have blurred. Real
Capital Analytics defines secondary markets as Atlanta; Austin, Texas;
Charlotte, N.C.; Dallas; Denver; Minneapolis; metro Philadelphia; Phoenix;
Pittsburgh; Portland, Ore.; Raleigh/Durham, N.C.; Salt Lake City; San Diego;
and Seattle; among others.
considered secondary, many of these markets have seen increased demand for real
estate, which has resulted in more leasing activity and sales transactions and
thus more market information, benefiting the valuation process.
secondary and tertiary markets have fewer properties that are attractive to
outside investors. While outside investors are showing increased interest in
small secondary markets, the majority of the transactions involve local or
size is not always a deciding factor for real estate investors. Tertiary
markets in North Carolina, for example, generally have a countywide population
of less than 150,000, with many having fewer than 100,000 residents. While
these markets are small, they generally have some attractive retail,
industrial, and office uses.
comparing market transactions, however, the difference in overall
capitalization rates between properties in larger markets and tertiary markets
may be minimal or nonexistent. For instance, a community shopping center in a
North Carolina tertiary market sold in fourth quarter 2012 at an 8.35 percent
overall cap rate to an out-of-market buyer. According to the PwC survey at the
time, the institutional nationwide average cap rate was 7.06 percent, a spread
of 129 basis points.
similar property in a larger North Carolina market sold at the same time for a
similar overall cap rate. The main reason for the similar valuations is the
tertiary market property is considered a class A location, while the larger
market sale is in a class B location.
appraise properties in secondary and tertiary markets, appraisers generally
need to dig to uncover data that will help them arrive at a market value for
the subject. Here are three major techniques they use.
comparables. Scarce local data can result in the
perception of a less-reliable valuation in the opinion of a lender or
purchaser. Appraisers can overcome this issue by making the client or user of
the valuation aware of the effort undertaken to find local data. When
out-of-market data is used, the appraisal must clearly show how it is credible
in the valuation. While there is often adequate data for smaller properties,
the larger investment properties often require comparative sales data from
outside the market.
example, we valued a new, single-tenant office building containing
approximately 90,000 square feet, leased to a credit tenant for 10 years in a
tertiary market. The subject property was under contract at the time of our
valuation. Based on the lack of local, comparable data, we used comparables in
other small markets as well as a comparable in a larger market.
larger-market comparable was also leased to a credit tenant for at least 10
years. The comparable was similar in quality, but slightly superior in age. The
subject’s net operating income on a per unit basis was slightly less than the
comparable, the result of lower land costs and the older age of the
improvements. The subject’s contract price was based on a 7.50 percent overall
cap rate compared to 6.72 percent for the comparable. The 78-bps spread is in
line with survey information and broker opinions when comparing properties in
larger markets to those in smaller markets.
local data from area experts. In small
secondary and tertiary markets, it’s crucial to interview brokers, owners, and
even the tenants when possible. We recently valued a U.S. post office in a
tertiary market with five years remaining on its original lease term with some remaining
renewal options. Our research found few recent rural post office comparables
with similar remaining lease terms.
interviewed during our research stated that based on the size of the property
and the rent level at the subject, a suitable alternative investment would be
small net-leased properties, similar to Dollar General or Family Dollar, with a
similar remaining lease term.
the property inspection, we interviewed the facilities manager, who said that
this U.S. post office was favored as it was located in the central business
district and across from the county government offices. The property had more
parking than the surrounding post offices, a higher percentage of leased mail
boxes, additional sorting and routing capacity available, and had recently
benefited from the consolidation and closing of another U.S. post office in the
this case we were able to overcome the lack of identical sales by considering
appropriate alternatives as supported by our discussions with brokers as well
as the tenant. Other good sources in small secondary and tertiary markets are
representatives of the local economic development committees, the local Chamber
of Commerce, and reporters.
EDC and the chamber are good sources for new businesses in an area and even for
information on businesses that are closing or relocating. EDCs often track land
sales in business and industrial parks and will have knowledge of property
sales and rents. In tertiary markets they are generally the most knowledgeable
in the local industrial market.
reporters are an overlooked source, especially in tertiary markets. Discussions
with reporters have uncovered zoning or council meeting minutes discussing
planned competition, road projects, major employment changes, and other issues
interviews to sort out inconsistent data. While
secondary markets attract out-of-market investors, tertiary markets mainly
attract local buyers. Generally, the result is a less sophisticated market and
buyer pool, which often causes pricing irregularities. For example, in late
2012, we valued a grocery-anchored center in a tertiary market that was under
contract using a 9.25 percent overall cap rate based on in-place income and
expenses. The same center sold in mid-2011 on an 11.0 percent overall cap rate.
transactions were arm’s length and met the definition of market value. The
decline in the overall cap rate resulted in a 20 percent value increase over a
year-and-a-half period. For comparison purposes, two national surveys had
overall cap rate declines of 2.0 percent to 4.0 percent during the same time
period. Factors considered in our valuation included the following.
population of the county (under 50,000) declined from 2000 to 2012 and was
projected to decline over the next five years.
unemployment was 19.2 percent, up from 11.5 percent in 2007.
was minimally better in 2013 than in 2011.
anchor had less than 10 years remaining on its original lease term at both
center was constructed in 1999 with one small shop bay having never been
adjacent center was vacant with the exception of seasonal use and storage.
subject’s anchor spent money in 2009 to renovate and update the store.
store sales were average for the market and have remained flat over the past
shopping center properties had overall cap rates in the 9.75 percent to 11.0
above factors painted an inconsistent picture of the market and the subject,
which is not too uncommon in tertiary markets. For clarification on the market
and how potential purchasers would interpret it, we relied on broker
conducted included local brokers for the local market knowledge and regional
brokers to gauge the depth of the buyer pool. In this case, according to both
sets of brokers, the only real buyer was a local buyer.
buyer for the subject was local, owned a similar grocery-anchored center within
20 miles of the subject, and wanted to purchase another center. The subject was
the only available center in the county, and based on the market data
available, the buyer was paying an above-market price for the center.
brokers, many with the CCIM designation, are important in the valuation
process. In addition to verifying comparables, they are crucial to
understanding the market and trends within the market. The relationship between
brokers and appraisers can be mutually beneficial and brokers should consider
appraisers as a good source of local and regional market information,
comparable data, and potential leads.
in small secondary and tertiary markets have become easier as more sources of
data are found online, but to truly gain market perspective, the appraiser must
speak with local brokers, market participants, and even tenants. As the real
estate market continues to improve, the smaller markets should see the benefits
of the recovery with more transactions, which in turn will make valuations in
secondary and tertiary markets more reliable.
Scott Jr., MAI, MRICS, is managing director of
Integra Realty Resources’ Charlotte, N.C., office. Contact him at