Appraisal: A tale of two buildings: Universally return to a more natural supply and demand market

In January, 2005 the One Seneca Tower in the city of Buffalo reportedly sold for $85.04 million when the building was near full occupancy. The largest tenants were HSBC Bank, the Phillips, Lytle law firm, the Canadian Consulate, and Price-WaterhouseCoopers. This 40 year old 38-story office building totals 850,000 s/f. It was formally known as the Marine Midland Center and later as the HSBC Center. Since 2005 the building lost almost all its tenancy. Today the building is almost 94% vacant. The biggest tenant HSBC Bank withdrew most of its presence from Upstate New York by selling it's branches. They consolidated their operations in the nearby HSBC Atrium and in a suburban office complex in suburban Cheektowaga. Phillips, Lytle who was HSBC's major law firm has downsized and recently moved to a new rehabilitated complex at One Canalside on the next block. Since One Seneca Tower was quickly losing its tenancy and of the anticipated inability of the One Seneca Tower to pay debt service and the $73 million balloon payment, the building reportedly was put in hands of a court appointed receiver. Recent court filings estimated the building value as low as $18 million and as much as less than $30 million. Based upon the original $85.04 million acquisition price this represents a reduction in value of 65-79%. 75 miles to the east in Rochester is the high quality office tower built by Bausch & Lomb 20 years ago at a reported cost of $70 million for their corporate headquarters but also had substantial space for other office tenants. This building reportedly is under contract for $15 million to a joint venture of three prominent local developers. The building currently has been vacated by Bausch & Lomb but reportedly has 9 tenants with 50% of the building vacant. There is 340,000 s/f of net rentable area. The $15 million purchase price would represent a 79% reduction from its $70 million original cost. There is myriad of reasons for this diminishment of value in these two Upstate New York downtown buildings. The primary overall reason is external obsolescence. External obsolescence is the diminishment of value attributed to factors outside of the property such as over supply and/or lack of demand. Functional obsolescence also has an effect. Functional obsolescence is the diminishment of value due to the inability of the subject property to perform to market standards such as in energy efficiency, floor plans, other deficiencies or super adequacies. The oversupply is attributed in part to the numerous local, state and federal programs which assist new projects. Real estate tax abatements, grants, low interest loans, economic development zones, etc artificially add to supply of space in varying degrees. This disrupts the natural supply and demand dynamic of the market. It's almost unheard of that a new project of any kind is completed in the northeast U.S. without one or more of these governmental programs. It's logical that if supply of any commodity is artificially increased the value or price of that commodity in the overall market will decrease. That's a major principle of economics. This is a major reason for large reductions to the values of the Buffalo and Rochester's examples cited in this article. Of course the ultimate solution is to universally reduce taxes of all types dramatically and wean the market off these subsidies. This will promote the natural supply and demand in the market. In the long run, there will be a long term preservation of equity and value. In the interim, investors and lenders will have to better synchronize their return of equity and loans over a shorter period of time. Yield for all investments are based upon the return "on and of" equity over a finite period. As an example, in the One Seneca Tower case in Buffalo, the lender should have required a shorter amortization period for the loan in 2005 in order to avoid the large balloon payment and create a quicker return of the principal. Furthermore, investors should be requiring a faster return "of" equity. The problem will be investors sacrificing return "on" equity or the annual "cash on cash" return. The key goal should be to find balance between return "on and of" for both the lender and the investors. Ultimately the long run solution is to universally return to a more natural supply and demand market or there will be more tales of other buildings. John Rynne, MAI, SRA is the president and owner of Rynne, Murphy & Associates, Inc., Rochester, N.Y.