Tuesday, June 19, 2012

Academia and International Real Estate

A good appraiser should have a solid academic foundation as well as empirically derived knowledge.

I have seen appraisers who did not understand that overbuilding causes rents and occupancies to drop, as they had not taken a college course in microeconomics. Discounted cash flow analysis, likewise, is chiefly taught in collegiate business schools, as is a sophisticated understanding of the concept of risk as it relates to investors’ expected rates of return.

Conversely, I have seen the growth of an academic real estate intelligentsia who has never gotten its shoes dirty, publishing scholarly articles about the behavior of people they apparently have never spoken to.  This is not an indictment of the academic community as a whole, but expression of a concern about a direction I see the academic community moving in regarding the teaching of real estate and the publishing of articles in scholarly journals such as International Real Estate Review. Some of today’s scholars are failing to talk to real word participants in the real estate industry and failing to perform field work, yet it behooves a scholar to have a complete knowledge of what he is writing about and the ability to teach practical skills to tomorrow's real estate professionals.

I first noticed this trend about 10 years ago as I read scholarly research relating to loan default modeling.  Scholars, many of whom were foreigners, developed multivariate models which included “appraised value” as a supposedly accurate fact, yet my friends who were residential appraisers regularly told me of the relentless pressure to deliver inflated appraisals, particularly as the mortgage industry became increasingly dominated the third-party-originators (such as mortgage brokers).  No one in academia or Wall Street was talking to appraisers.  Assuming that appraised value is indeed a factual indicator of value is a dangerous assumption, and that applies to commercial appraisals, too. Just ask any appraiser.

I consider myself lucky to have had some excellent real estate professors such as William Brueggeman (SMU), Kerry Vandell (now at University of California Irvine by way of U of Wisconsin) and Richard Peiser (now at Harvard), scholars who also had experience working in or with the private sector and could meld both real-world and theoretical concepts into their instruction.  I also notice that some universities, such as the University of Southern California, have seasoned appraisers teach real estate valuation, Ph.D. not required.

I also see other faculties increasingly dominated by professors whose only previous experience was as foreign graduate students in this country, and I see little to indicate that they were working real estate practitioners in the countries they came from.  Foreign nationality could be an advantage if they were teaching courses in International Real Estate, but almost none of them teach such a course, as such a course is rarely offered in the United States.

I have recently read the articles of university professors modeling the behavior of real estate developers.  Developers are described as carefully considering the exact amount of demand for their product and building no more than necessary to satisfy that demand.  Who did these scholars talk to? 

That type of demand analysis is something I would have liked to have done when coming out of graduate school in 1984. I interviewed for jobs at four development companies in Dallas, including Trammell Crow, and the response I got each time was “We can get 100% financing for our project.  Why analyze?” Of course, this reflected the general craziness of the Texas banking industry in the 1980s, but my work still has me constantly meeting and even traveling with developers, sometimes sharing breakfast, lunch, drinks and dinner with them, and their desire for 100% financing still exists, except now they have to trick lenders into financing 100% of the project (which involves trying to trick the appraiser, too). Misrepresentations abound, such as:

We’ve already installed water and sewers.”

“We’re 90% pre-sold” (with many of the buyers being LLCs or friends with addresses in the developers’ same, distant home towns).

“Our final map will be approved by the County any day now” (or maybe it was rejected last month).

“We’ll be getting tax credits.”

“The City of Podunk has already approved $40 million in bond financing for us” (just wait until Podunk tries so sell such bonds).  Besides, bonds are liabilities which have to be paid back, and end-purchasers will just deduct their share of bonded indebtedness from their purchase offers.

Never has a developer told me, “My analyst told me to develop much less than allowed, based on his research.”  Few developers employ analysts. Developers generally develop to the limit of their entitlements.  If they are legally permitted to develop 100 homes on a site, they almost always will if it physically possible, even if the development is in phases, and I have seen this behavior outside the U.S., too, including Canada, Brazil, and Latin America. No developer has told me that he wanted to develop less than his entitlements.  That would mean having to ask for a smaller loan, and most everything in this business is done with “other people’s money”.

Are developers rational?  Hell, yes, but just not in the way the scholars see as rational. It's all about maximizing return on equity, which is best done by minimizing or even eliminating equity.

As a former, part-time University instructor, I have no hostility to the academic community, and I would like to extend an invitation to Academia to have a member accompany me (at University expense) on each international valuation assignment as a way of "putting heads together".  I have possible upcoming assignments in Germany (a 1 million square foot logistics center in Norderheine-Westfalen), Costa Rica (residential development projects), or Ecuador (prospective solar farms) but bear in mind that I typically travel on short notice.

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ant. a. said...

Great post as usual Vernon. Having been in academia myself for a while, I can attest to its propensity to utter uselessness. It can be as unrelated to the real world as an appraisal report can be to the real estate market.

Vernon Martin, MSRE, CFE said...

Touche', Ant. Appraisers can be just as clueless.

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