Factors that Create Value:
Value pertains to the relationship between a thing desired and a
potential purchaser. The important word here is relationship,
meaning that value is not inherent in any object. Value is created by
and varies with changes in this relationship.
The four essential factors involved in this relationship and
that, when acting together, create value in any object are: 1)
Desire, 2) Utility, 3) Scarcity, and 4) Effective Purchasing Power.
Effective purchasing power is necessary to implement desire for
any object that has utility and when the object is scarce, produces
value. Money is the most common form of effective purchasing
power today, but it can be anything of perceived value between
the purchaser and seller. These four factors cannot create value by
themselves, but must work in concert for any object to have value.
Credit’s Affect of Commercial Real Estate:
Although location, interest rates, rent growth, and CAP rates have
a significant impact on commercial real estate valuation, I believe
that credit — which creates liquidity — has the biggest impact.
What we are seeing today in Las Vegas, and many other markets,
provides all the evidence needed to support this conclusion.
We live today in a world of virtual money. Money can go from
our employer, to our bank account, to our favorite retailer or res
taurant, without ever materializing. Money is no longer a physical
commodity and since 1971, no longer metal, but is intangible; it
is this virtual money which dominates our money supply. In our
electronic age, “nothing” serves as money, too. Like credit, money
has become a matter of belief; it is trustincorporated.
The proliferation of more sophisticated forms of credit in the
past 20 years, characterized by such things as hedge funds, col
lateralized debt obligations, derivatives, and credit default swaps,
created an age of easy money and, more than anything else, this
liquidity drove the value of commercial real estate through the roof.
TABLE 1
COMMERCIAL REAL ESTATE CREDIT SOURCES
2005
Banks
(Aggressive Lending/Limited
Regulatory Oversight)
CMBS
(At peak close to 30% of debt
market)
Life Insurance Companies
(Active)
Hard Money Lenders
(Several)
Seller Financing
(Not Significant)
2011 – Present Day
Banks
(Many Liquidated,
Consolidated or Impaired/
Strict Regulatory Oversight)
CMBS
(Limited Issuance)
Life Insurance Companies
(Limited)
Hard Money Lenders
(Gone)
Seller Financing
(Becoming more Prevalent)
Imagine if the next time you went to buy a car, the dealer would only accept cash and financial institutions were no longer making auto loans. What do you think would happen to the price of auto mobiles? How many restaurants, grocery stores, and other busi nesses would survive on a cashonly basis?
Valuation Today
Today, commercial real estate must still be valued using the three
traditional methods: cost, income, and market data approach.
When combined, all three are very effective in arriving at the
current market value. But properties should be segmented with
attention to liquidity and financing issues.
