The news from Lake County has been absolutely devastating.  The Valley Fire has been ranked the 3rd most destructive wild fire in California's history.  The Santa Rosa Press Democrat reports that "1,958 buildings were destroyed, including 1,280 homes, 27 multifamily structures, 66 commercial properties and 585 other structures such as outbuildings and sheds. Four people died in the blaze that began on Sept. 12 and has burned 76,067 acres."   This is a major blow to a county that was beginning to recover from the economic recession.

I cannot imagine what the residents must be going through, and I'm sure many are still in a state of disbelief and despair.  We will have appraisers heading up to Lake County in the coming days to see the damage first hand and begin the process of valuing these properties as of the day before the fire broke out.  

Prior to the appraisal, property owners should familiarize themselves with their insurance policies and be in contact with their insurance agents.  Since the properties may be completely or partially destroyed, owners will need to help the appraisers understand the condition and quality of the improvements so that an accurate value can be estimated.   

​Our hope is that Lake County will quickly be able to rebuild and thrive once more.  

For as long as the Federal Reserve has been buying mortgage backed securities and Treasury Bills, we have been warned that the end of Quantitative Easing (QE) will mark a rise in interest rates and a corresponding increase in Overall Capitalization Rates (OARs or Cap Rates).  QE3 ended in October 2014 and many capital market observers expect the Fed to begin to increase the Fed Funds rate (and therefore all rates) in early 2015.   We have yet to see an increase and rates are at or near historical lows.

Mathematically, an increase in cap rates would lead to a decrease in value, all things being equal.  Think about the long-term leases with minimal or no rent increases.  An increase from 6.50% to 7.00% on level income leads to a decline in value of 7%.  Alternatively, income would need to increase 7.7% in order to maintain the same value with an increase of 6.50% to 7.00%.  Your long-term Net Leased assets, the best of which have 10% rent increases every five years and the worst are flat for 20 years, are most susceptible to overall rate increases.  

Some advisors have speculated that it is time to shift from these net leased assets to properties that are actively managed or can be repositioned to take advantage of rising market fundamentals (rent increases and higher occupancy).  However, the "coupon clippers" have become so attractive in recent years in large part because of the ease of management, relatively low risk of tenant default, improvements that are recently built and have excellent locations.  It is also true that the market has known of the potential for increasing interest rates and the end of the bond buyback program for a long time, so it is hard to imagine that these investors did not price this risk into their purchases or investment strategy.  If rates rise too much, investors that need to sell an asset in an increasing cap rate climate could be hurt.  I suspect that if rates do increase substantially that we will simply see fewer re-sale transactions.  On the development side, it may result in the negotiation of higher rental rate increases throughout the term, so as to make it more palatable to develop Net Leased Assets.  However, in order to increase rental rates for new deals, development would only occur if tenants can afford a higher rental rate. 

Do you have a different take?