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ABSTRACT
The accelerated nature of the last real estate cycle was partially fueled by investors' and analysts' expectations of aggressive rent projections. By examining the historical record of rent growth and the likelihood of achieving market rent increases, appraisers, investors, and analysts can add a dose of reality to their forecasting assumptions. Understanding the impact of rent spikes in cash flow projections is critical to gauging the inherent risk and selecting the corresponding discount rate for projections as the next cycle emerges.
The most common question asked to real estate analysts nowadays is, when will the market return to normal? Analysts could reply by asking, when do you think the market was normal? A likely response would be, early 2007. However, the market peak in 2007 does not represent a normal market
Classic economic theory states that normalized markets display a balance between supply and demand, with financing rationed in measured ways by sound underwriting standards. In the public securitized debt market this would include rigorous and appropriate agency ratings. In other words, early 2007 was anything but normal. In fact, markets are seldom if ever normal. Markets are fluid; they are always moving up or down the investment curve, and the velocity at which the market moves can usually be tied to one of the market influences being out of sync. Be thankful for these disconnects, however, because it is exactly the imbalances that create opportunities for property buyers, tenants, and financial institutions. Those who recognize these imbalances and can anticipate market shifts will undoubtedly make better decisions regarding the purchase, occupancy, or financing of property.
From 2001 through 2003, real estate markets began to regain their legs after a prolonged recovery that started in the early 1990s. Cheap money provided the impetus for early property buying despite the absence of any compelling reason provided by improved real estate fundamentals. Furthermore, asset appreciation was almost entirely the result of yield compression and only marginally related to income growth. From 2004 through 2006, real estate fundamentals- namely income growth- strengthened. The perfect storm gathered and hit in mid-2007, resulting in the collapse of financial institutions. The period from 2005 through mid-2007 could only be characterized as markets racing towards a precipice with easy money...