Establishing Value in Commercial Real Estate

With investment property, historically the income approach is used. Basically the property's rental income, less the owners operating expenses provides the Net Operating Income (NOI). Dividing the NOI by the prevailing Capitalization Rate (CAP Rate) provides a Market Value.

Leases were written five years ago or longer (before the economic crash) at high rental rates. With these tenants still in the building the current year's financial analysis looks pretty good. However, going into the next two years some of these leases may expire.

If we project an income analysis for the next year or two, due to anticipated lower rental income, the NOI is less, as would be the market value. Owners must understand a buyer will look at this before making an offer. Commercial real estate professionals, need to do a five year projection (or longer), of the property's future financial performance to show the real future value. We may see a projected reduction in value over the next two years, but then toward the end of the cycle we may be able to show a gain in value.

Another basis of comparison used today is comparing costs per square foot. Historically, this compares the subject property to recent similar sales. But we had fewer sales in 2009 and 2010, as financing was not available. Since 2011 we have seen slow but increasing sales activity. To equalize different sizes of similar buildings, the asking price is broken down to a cost per square foot. Trends become apparent, for example, if there are three other office buildings for sale in the area averaging a cost of $100 per square foot. The probabilities of a buyer paying much more is slight.

With the cost of rental space being lower, the focus on rental value is now largely also based on local competition. If a competing property is averaging an asking price of $15 per square foot, it would be difficult to rent space at $25 per square foot. Owners may not like the current value realities, but buyers and tenants will not pay more.

George Bakes is a commercial real estate broker in the Del Mar office of Coldwell Banker Commercial NRT, 2651 Via De La Valle, Del Mar, California 92014, 858-602-2799, george.bakes@coldwellbanker.com; sandiegogocommercial.com.