Scheer Insights

Property Valuation: The Endowment Effect

We’ve been working on acquiring a portfolio of properties in the Maryland suburbs of Washington DC. This portfolio is largely older buildings, a mix of industrial, medical, neighborhood retail and office. We carefully developed assumptions for leasing these properties and what the likelihood of deferred maintenance would be. We combined this with a cap rate approach for both the portfolio and on all the properties holistically. We proposed a number at a 7.5% Cap Rate based on the owner’s 2018 projections. The owner, after discussing with his accountant decided that his property was worth a number that placed the cap rate at 4.6%.

Also, recently, we looked to acquire an office building located in the North Rockville submarket. I underwrote this building and determined that a high 8 cap would be appropriate. With high competition and vacancy in the market, this building was going to have a difficult time competing in the long run. We thought our offer would allow us to offer generous TI packages to tenants and make cosmetic upgrades to the building. The owner said he wouldn’t sell for anything worse than a 6% cap rate.

These two experiences made me think about the endowment effect. The endowment effect describes our tendency to value things more highly when we already own them. If I’m trying to sell you my car, I might think it’s worth $10,000, while you might think it’s only worth $7,000. When it comes to buying a less than perfect asset, unless you have a radically different vision for a property it is very difficult to overcome the endowment effect. The owners of these properties aren’t considering the many flaws their properties have and the risks we would have to take to keep them competitive. To be competitive as a value-add owner you have to have your unique talent or value to bring to a project. Can you bring a tenant into the fold that the current owner can’t? Can you completely change the use of the building, say from office to lab? Do you see untapped value such as abundant parking that could be rezoned for housing? Overcoming an owner’s overestimation of the value of their property is hard and requires a new perspective.

Posted by Matt Brown, Director of Acquisitions

Montgomery County’s Economy

Empower Montgomery recently commissioned Sage Policy Group to analyze the economy of Montgomery County, Maryland. The results show a county in economic decline while the country and neighboring counties are thriving.

Some key notes from the report include:

  • Montgomery County netted 6 new companies between 2011 and 2016 despite the State of Maryland expanding by nearly 6,300
  • Montgomery County was home to fewer jobs in 2016 than 2006 even though the count added more than 11,600 public sector jobs
  • Over three times as many square feet of office space is being developed in Northern Virginia than Montgomery Count despite a higher vacancy in Northern Virginia – speaking to relative optimism of business growth

What does all of this mean to a real estate investor?

  • Price in what it will take to lease space in a competitive market. Concessions such as free rent are increasing as tenants now have more leverage – I believe these will continue to increase. Investors need to make sure these rising costs are correctly accounted for.
  • Do not expect the market to be in a significantly different place in ten years than it is now. According to CoStar, average rental rates have only now reached where they were during the decline in 2009 and are still $1 per square foot less than their peak in 2008. Many investments are successful because of the owner’s ability to push rents over time. There is no reason this will occur in Montgomery County.
  • Look to non-office Real Estate Investments. Industrial has seen a rapid rise in rental rates. Existing Multifamily and Residential, while already expensive, benefit from the resistance of the government to add new housing. Niche assets like parking lots, life science facilities or self-storage may be poised to perform better than office.

Posted by Matt Brown, Director of Acquisitions

Picking the right equity partner

We recently acquired a building and went to the market looking for an equity partner. We needed someone to put up more than $5.5 Million of equity. We talked to several partners and at the time I viewed them all as essentially the same, large companies with money to lend. We, fortunately, found an excellent partner but when making our decision I did not realize how different each partner could potentially be. I will be sure to ask myself and potential equity partners the following questions next time:

1. What will their involvement be?
a. What value do they bring to the table as investors?
b. Does this overlap or complement our own strengths?

2. How much work do we have to do to work with them?
a. Do they have complex reporting structures?
b. Are they publicly traded and must abide by greater SEC regulations?

3. Who will control the flow of money?
a. If we need to pay a contractor, where is this check coming from?

4. What type of banking relationships do they have? What type of debt will can they anticipate?
a. A partner that can bring cheap debt saves a lot of money.
b. Are they willing to guarantee a portion of the loan?

5. Does this deal have an expiration date for them?
a. Is this in a fund that needs to be closed in three years?
b. What if the market turns and it is best to extend the length of the project?

6. What will our organizational structure look like with them as a partner?
a. Do we need another equity partner to pick up a piece?
b. How many entities must be created to execute this project?

It is great to find a partner that offers cheap money, but many other factors are just as important. Fully vet every potential partner understand what the relationship will look like over the life of this project and beyond.

Posted by Matt Brown, Director of Acquisitions

2017 – 2018 Capital Markets

I have been trying to absorb as much information about the state of capital markets for Real Estate as I can. Reports on the “State of the Market” always pop up around the new year and I have been reading as many of them as possible. Below are a few interesting notes I have read.

  • Washington DC is the number 4 city in the United States for foreign capital investment
    • Up from #5 last year
    • London passed NYC for #1 internationally
    • Washington fell from 15th place last year to 25th place internationally
    • Of the top 10 investors in the DC Metro Area in 2017 – 7 of them were foreign entities
  • Foreign investors are more interested in Industrial than any other asset class
    • Followed by Multifamily, Office, Hotel and Retail
  • Current Cap Rates are at or near record lows
    • Washington, DC and Seattle have hit their all time lows in Cap Rates
    • CBD Cap rates rose 20 bps from 2016 but were still 110 bps lower than average
  • Deals are moving out the risk spectrum to chase returns
    • Record Low cap rates force investors to chase returns from riskier assets
    • Suburban Office deal volume hit a record high
    • Medical Office Space deal volume increased 22%

Clearly, foreign investors are driving the investment in CBD properties. With a future of higher interest rates, investors cannot underwrite cap rate compression and are chasing more development, construction and suburban deals to get their desired returns.

Thanks in particular to REAL Capital Analytics for most of the data used.

Posted by Matt Brown, Director of Acquisitions

1031 Exchanges – A Basic Overview

1031 exchanges have a huge impact on the real estate market. I was recently looking at a property for Scheer Partners to acquire but lost out to an out of town buyer who had to complete a 1031 exchange. My uncle recently sold his home in Maryland and bought a new one in California with 1031 money. Congress has even been talking about eliminating them in their tax reform package, although it appears they will remain solely for real estate transactions.

1031 exchanges account for approximately 30% of annual real estate transaction volume. Analysts estimate that eliminating the program would result in a short-term drop of 4.6% – 8.0% in property values.

Clearly the 1031 exchange program is bigger and has a greater impact on the real estate market than one might have anticipated so I decided to speak with David Christopher, CPA at our accounting firm, Santos, Postal & Company, P.C. ( for some more insight on how 1031 exchanges work and how they impact investors such as myself.

Can you quickly explain a 1031 exchange?

A 1031 exchange occurs when you have a sale of business or investment property (in most cases, real estate), in which you would normally have a taxable gain, but because you are reinvesting the proceeds of the sale in a “like-kind” (i.e., similar) property as part of a 1031 exchange, the gain on the sale is deferred.

A common misconception is that this is a tax-free transaction. Depending on future events, it could turn out to be tax-free, but initially, it is simply a deferral of the tax. Also, depending on the exact circumstances of the transaction, there may still be some gain that is taxable in the period of the exchange. For instance, if cash, or “boot,” as it is often called, is received, or if your debt on a property is reduced via the exchange, taxable gain may be recognized.

Why would an investor with 1031 money be able to offer a higher purchase price than an investor without it? Can you give some numerical examples?

Let’s look at two basic examples:

Example 1: Investor A sells a property worth $1,000,000. He has hired a Qualified Intermediary and they have identified a property he plans to exchange it for with a value of $1,000,000, owned by Investor C. In this transaction, ignoring brokerage costs, fees, and any other buying and selling expense, he will not need to come out of pocket at all for the new property. He will have no taxable gain.

Example 2: Investor B recently sold a property for $1,000,000 that had a gain of $200,000.  He wishes to use his proceeds to purchase the same property from Investor C as illustrated in Example 1 above. However, because he had a taxable sale and will need to pay taxes on the amount of the gain, he needs to retain some cash to pay the associated taxes (we will assume a 25% combined tax rate, so $50,000). Therefor

Are there any limits to how much money someone can save or who can take advantage of this program?

There is no limit to how much tax you can defer with a section 1031 exchange. If you are exchanging like-kind property with values in the billions that would have taxes of millions, it is fair game. The primary limitation is that you must identify a like-kind property to consummate the exchange within 45 days of your property sale; and, then you also need to close on the new purchase within 180 days of your property’s sale. Also, while the definition of “like-kind” property is vague, cash is not like-kind to a building, providing another limitation. That said, land is considered like-kind to a building, or multiple buildings, so there is some flexibility.

There are other restrictions as well. As stated previously, 1031 exchanges are for investment or business property, not personal property. You cannot exchange your personal residence for another. And if you convert an investment or business property to a residential property and immediately put it to use as your personal residence, the IRS will disallow the transaction and all gains will be taxable.

What would you advise someone to do if they were selling a building and would soon have potential 1031 money to reinvest – what are the financial repercussions?

I would hope they have already consulted with their real estate broker, attorney, and certified public accountant. If not, these should be their next phone calls. Hopefully, a seller has already called the required professionals and is using a Qualified Intermediary for the sale, as well as keeping the sales proceeds in escrow. If they sold the property and have already received the proceeds or had a note paid off with the proceeds, it is too late to retroactively turn this into a 1031 exchange. The financial repercussions could be enormous as they would be liable for taxes on the gain of the sale. Assuming they were proactive and listened to their professional advisors, I would advise them to move quickly in identifying a property to acquire as there are tight deadlines, both in identifying the exchange property and for closing on the purchase. If they can identify a property and make a purchase within the allotted time period, they would be able to defer most, if not all, taxes due from their original sale, and the financial repercussions would be negated.

Please note, these decisions need to be looked at from more than purely a tax planning mindset. If you are buying a property through a 1031 exchange only to defer the taxes on a gain, but the new property turns out to be a poor investment, the cash flow implications over time could be worse than had you simply paid taxes on the gain of the original sale.  Therefore, it is important for the investor to properly analyze and perform due diligence in their search for a new investment property.

Make sure this process is thought through completely. There are too many rules and guidelines to explain in this limited space.  In our experiences, we have seen 1031 exchanges get reversed for errors made and misunderstandings on the part of the client or the Intermediary. If your readers learn nothing else, it is always wise to consult with professionals before attempting to engage in a Section 1031 exchange.

If you have questions about where to start, please feel free to contact me at or contact David Christopher at either or 240-499-2067. We would be more than happy to discuss the process with you in greater detail.

Posted by Matt Brown, Acquisitions Analyst, with insight and thought leadership provided by David Christopher, CPA

Overpriced Assets

I previously wrote about how many investors are proceeding with caution because assets are starting to command higher and higher purchase prices and that the market may be overpriced. I took this statement as factual because of the many accomplished industry veterans who alluded to this point. However, I wanted some stats to back up this claim.

First, I looked at trading volume in DC. According to a recent Real Capital Analytics report, volume of properties being traded in the Washington, DC Area is up over 5% year over year. This is a sign that investors see value in the market. Additionally, year over year prices for real estate assets are down 5%. The DC Metro area is one of only four global cities that has not seen overall prices increase since 2006 (along with Amsterdam, Tokyo and Chicago) and those other cities all had year over year price increases.

The building we have our offices in, 15245 Shady Grove Road, traded for $24.8 Million in May 2017. That is down from the $32 Million it traded for in August 2011 and the $33 Million it traded for in January 2002. Occupancy levels decreased significantly but so did the cap rate.

Prices are too high now because investors are more conservative.

If prices are too high – then they were WAY too high a few years ago.

 What does this mean?

Investing in suburban real estate is not a clear vehicle for growth that it was once considered. Some properties are durable. Buildings in walkable, transit-oriented communities continue to see their valuations increase at the expense of their more remote competitors.

If you are investing in a property you better have a plan. Do you plan to convert it to self-storage (4 Research Place)? Do you plan to capitalize on unused FAR and favorable zoning and build residential on the property (700 Quince Orchard)?

The investors who will have success in this market are the ones with a specific plan that is unique or sees the property in a way that others do not.

What is it?

1031 Exchanges

1031 Exchanges are a way for an individual to continually reinvest profits from one real estate venture into another without paying taxes on that gain.

Example: Say I purchased a property for 100 dollars and 5 years later it is worth $150. If I were a rich man I would have to pay the 20% capital gains tax on $50 gain. However, section 1031 of the IRS tax code allows that gain to be reinvested without being taxed. Now I have $150 that I can use as the 20% down payment on a $750 property. If that property appreciates, I can roll the profits forward again, continually buying more or bigger properties.

This is not a way to avoid taxes altogether because eventually, the IRS will get their money if you decide to cash out and sell all properties without buying a new one. However, if you can make a living off the cash flows the property provides, this is a good vehicle to grow and buy bigger and more properties.

Posted by Matt Brown, Acquisitions Analyst

Lupert Lessons

I was fortunate enough to attend an event with DC’s “The Real Estate Group” last week. During the dinner, Dean Adler, founder of Lubert-Adler Partners LLP (, spoke to all attendees about some of his principals for investing. I thought many of them applied well to Scheer Partners and what we are trying to do with our acquisition and development platform.

Partner with Experts – Mr. Lubert said when he began to grow his company, his strategy was to develop close relationships with 2-3 excellent partners in each major US market. He believed that these local partners would always beat out two analysts from global firms who simply parachute into a market to execute a few deals. Deep knowledge of a specific market or product type are invaluable to him.

At Scheer Partners, we are an elite sponsor for any project in Montgomery County and any lab/biotech related project nationwide. Understanding our area of expertise and continuing to bolster that specific knowledge will continue to give us a competitive advantage over our competitors.

Learn from mistakes but MOVE ONE – Mr. Lupert lost a lot of money in the 2008-2009 Market Crash. He was in a daze for months just trying to see where he went wrong. He had recently developed a community of vacation homes that had been wildly successful but when the crash happened that investment went bust. Mr. Adler developed a new game plan based on new market realities. He went to equity partners such as university endowments who still had money to spend and convinced them the time was now to invest with him. These investments are a big part of why he is successful today. He learned from his mistake of investing in “discretionary assets” towards the end of a real estate cycle and immediately moved on.

At Scheer Partners we have successfully executed many projects in the DC Area. But there have been some investments that haven’s been home runs for one reason or another. A few things that we are very conscious of when investing now are realistic market rent growth, supply and demand factors that could impact the related job markets, the appeal of each unit in the project and where in the cycle we are for our specific product type. Learning from past mistakes has made us much stronger developers.

Reputation and Trust is Everything – Everyone involved in an investment must have complete trust in you as the general partner. Your word and ethics are everything. When Mr. Lupert went back to investors after the market crash, he says that the reason they invested with him was because of a long track record of being a faithful steward of their money. He may have been able to get a few deals done here and there without being an honest and ethical partner but his relationships would have suffered and he would not have been able to grow his business

At Scheer Partners we have had a reputation for not only getting results but for treating all of our partners honestly and with the highest ethical standards. We have had a presence in Montgomery County, MD for almost three decades and would not have been able to sustain this track record of success if we hadn’t built long term relationships based on trust.

Thanks again to the DC Real Estate Group for hosting a great event and Mr. Lupert for giving a valuable talk.

Posted by Matt Brown, Acquisitions Analyst

Analyst Insights: Industry Cycle

A few months ago, I attended a talk hosted by Bisnow “State of Montgomery County” and a conference hosted by IMN “U.S. Real Estate Opportunity & Private Funds Investing Forum”. It seemed that most investors were concerned about the rising cost of real estate. Many panelists spoke of where we are currently in the real estate cycle ( and used the old baseball analogy of “what inning are we in?” The consensus is clear, we are in the later innings of the game or the “hyper supply” part of the cycle.

I had my own unique takeaway from these conversations. I think that these cycles are way too broad of a brush to paint with and cannot really be applied to current conditions. It is clear that developers are proceeding with extreme caution in terms of ground-up development. Instead, the flavor of the times is to reposition underutilized assets. Doing this doesn’t increase supply the same way a new building would. According to a quick CoStar search the 5- Year average for office space in Montgomery County (buildings above 10,000 SF) is 69.6 million SF. Currently, that number is only 70.3 Million SF. This 1% increase in supply doesn’t feel like “hyper supply”. Instead, repositioning assets and abandoning properties that served businesses of previous decades and creating more modern workspaces is occurring. This is creating more efficiency, not oversupply.

While my above statements apply to commercial office properties, I do believe that Multi-Family is likely in the “hyper supply” phase of the cycle. This product type has been the darling of the real estate industry for years now. In Silver Spring, MD there are currently 3,300 new residences planned for delivery (

Maybe it is time to look at suburban office that has been neglected over the years and maybe it is time to sell multifamily assets.

Posted by Matt Brown, Acquisitions Analyst

Introducing, Analyst Insights

This is Matt Brown, I oversee Acquisitions and Underwriting for Scheer Partners in Rockville, MD. I am starting this blog to share some of the insights I gather about real estate that I gain from conversations with industry experts, market reports, real estate conferences and our own personal successes and failures. I have the distinct advantage of working next to many of the best leasing and sales brokers in the industry on a regular basis. They provide me with real time information about what type of space tenants they represent are looking for and what landlords have effectively done to beat the competition. Also, I am fortunate to work with many of the best accountants and lawyers who provide me valuable insight into many of the finer points of real estate. Enjoy!

Posted by Matt Brown, Acquisitions Analyst