Market Feasibility and Appraisals (Part 2)

Part 1 - How Does an Appraisal Work?

Q: How Does a Market Feasibility Study Work?

A market feasibility study determines the depth and condition of a particular real estate market and its ability to support a particular development.

The key concern of a market feasibility study for multifamily development is a project's ultimate marketability. Therefore, the market feasibility study must determine the following:

1. What is the current condition of the market?
2. How will the market respond to the proposed project?

Determining Market Condition

To determine current market condition, The Danter Company has developed several key methodologies which work together to give us a clear picture of any multifamily market. The most important of these methodologies are the Effective Market Area^SM (EMA) and the 100% Database.

The first step is defining the extent of the market area, because not all market areas are alike. Several basic methods exist for determining the appropriate market area.

One common method is radial analysis. In this method, a series of concentric circles is drawn around the site at, for example, distances of 3, 5, and 10 miles. The areas within these circles are then analyzed. This method is usually employed for one reason—it is easy.

A second method, particularly common in studies for governmental bodies, is to base market areas on boundaries between governmental units. In such a method, county, township or city boundaries might become the boundaries of the market area. This, too, is an easy solution since most secondary data are reported by political delineations.

A third methodology, developed by the Danter Company, is the Effective Market Area. The EMA is defined as the smallest geographical area from which a project can expect to generate 60% to 70% of its support. It is not as easy, but we think it gives us a better reading of the true market area for a project.

When we determine an EMA for a project, we look at several factors, including geography, demographic analysis, mobility patterns, and area perceptions.

Geographical factors—rivers, railroads, freeways, hills, and major arteries often define neighborhood boundaries. Such geographical factors, which can play a big part in where people move, are ignored in radial analyses. In addition, geographical factors can often be more important than governmental boundaries, as market areas often cross county, township, or city borders.

Demographic factors--population and household trends, housing and income characteristics, differences in socioeconomic makeup of individual neighborhoods, and growth figures all are analyzed to help identify the EMA. Radial analyses cannot take all these characteristics into account, and often can skew a report by including neighborhoods of vastly differing socioeconomic makeup, as can analyses based on governmental boundaries.

Mobility factors—interviews with area real estate professional and civic officials are combined with our past experience in determining mobility patterns. Mobility patterns within an area are predictable, and while individuals occasionally act counter to prevailing trends, mobility analysis can help pinpoint where the majority of tenants for a particular project are the most likely to come from. Radial analyses cannot make these distinctions.

Area perceptions—we conduct interviews with area officials and real estate professionals to determine area perceptions and how they relate to the previous factors. Area perceptions are important in helping determine mobility patterns, a key component of any market feasibility study.

Our research indicates tenants already living in an apartment within the EMA are the largest single component of support for an apartment project. Typically, an apartment project can expect between 45% and 50% of its tenants from other apartments within the EMA. Add support from within the EMA from new household formation, current home owners, or other rental properties, and the total EMA support increases to 60% to 70%, depending on the demographics of the EMA.

As a result, our EMA is a Supportive EMA and not a Competitive EMA. A Competitive EMA would consist of the projects most likely to compete with a proposed project for support. Therefore, a Competitive EMA is likely to include projects with a similar price point or amenity level to the proposed project, or perhaps even projects from outside the Supportive EMA. However, since the Competitive EMA includes only similar projects, it is only a subset of the Supportive EMA. Analyses using a Competitive EMA only examine a portion of the market at one pricing level, and then perhaps not all similar projects.

Next: The 100% Database and Determining Market Response