I am new to commercial real estate and want to buy a building that is not necessarily on the market but the owner is currently leasing it to us.
I want to offer an intelligent amount that doesnt make me look as inexperienced as I am, and I was told to use the capitalization rate to determine its value.
The property is a standalone building in California, is 6000 sq feet, rents for .90 cents a square foot including triple net. This is all I really know
Can someone help me?
Thanks,
Commercialrookie
Full Version: How to use capitalization rate
In order to use capitalization rate you need something to apply it to. The number that you are looking for is the Net Operating Income or NOI. Once you have that it is divided by the cap rate to get an estimate of value.
NOI is computed by deducting operating expenses from rental income. Therefore, the first step is to figure out how much is the rental income.
We know that the property has 6,000 Sq. Ft. and that the rent is $0.90 per Sq. Ft. However, there is something not right with that $0.90 per Sq. Ft. number. It is just too small! Rental rates per Sq. Ft. are quoted on a yearly basis and even warehouse space located in the worst of neighborhoods goes for at least a couple of dollars per year. Lets say that they quoted you the rental rate per month, then you would do $0.90 X 12 = $10.80 per Sq. Ft.
The potential gross income is then easy to calculate 6,000 X $10.80 = $64,800
However, potential gross income is not the same as actual income. You really need to know the actual vacancy rate of the property and the vacancy rate for similar properties in the neighborhood. A trick of the trade is to assume a 5% vacancy rate as natural and just deduct it from potential income. That would mean that you would end up with a certain amount of revenue at an "stabilized" state. But if your building is not 95% occupied then you have to account for the expenses and time needed to get the building stabilized. For the purposes of this example, lets assume that the building is stabilized. Then your income would be:
$64,800 - $3,240 = $61,560
Next step is figuring out the expenses. If leases are triple net then it means that the tenants pay for most of the expenses. However there are a few expenses that might need to be taken care of by you for different reasons. Lets be gentle and say that an additional $3,240 in expenses will be incurred.
$61,560 - $3,240 = $58,320 (NOI)
Ok, we got the NOI, now what capitalization rate are you going to be using? Well that depends of the location, the tenants involved, and the type of property. It can really vary a lot, but anything under 6.5% would be unreasonable in my opinion. The right rate is the key to a good estimate. Look at the impact of different rates on estimates of value below:
$58,320 Divided by a rate of 5.0% equals a value of $1,166,400
$58,320 Divided by a rate of 6.5% equals a value of $897,231
$58,320 Divided by a rate of 7.5% equals a value of $777,600
$58,320 Divided by a rate of 8.5% equals a value of $686,118
$58,320 Divided by a rate of 9.5% equals a value of $613,895
P.S: This is just a rough example. You need more information than what you have to estimate the value through the income approach.
NOI is computed by deducting operating expenses from rental income. Therefore, the first step is to figure out how much is the rental income.
We know that the property has 6,000 Sq. Ft. and that the rent is $0.90 per Sq. Ft. However, there is something not right with that $0.90 per Sq. Ft. number. It is just too small! Rental rates per Sq. Ft. are quoted on a yearly basis and even warehouse space located in the worst of neighborhoods goes for at least a couple of dollars per year. Lets say that they quoted you the rental rate per month, then you would do $0.90 X 12 = $10.80 per Sq. Ft.
The potential gross income is then easy to calculate 6,000 X $10.80 = $64,800
However, potential gross income is not the same as actual income. You really need to know the actual vacancy rate of the property and the vacancy rate for similar properties in the neighborhood. A trick of the trade is to assume a 5% vacancy rate as natural and just deduct it from potential income. That would mean that you would end up with a certain amount of revenue at an "stabilized" state. But if your building is not 95% occupied then you have to account for the expenses and time needed to get the building stabilized. For the purposes of this example, lets assume that the building is stabilized. Then your income would be:
$64,800 - $3,240 = $61,560
Next step is figuring out the expenses. If leases are triple net then it means that the tenants pay for most of the expenses. However there are a few expenses that might need to be taken care of by you for different reasons. Lets be gentle and say that an additional $3,240 in expenses will be incurred.
$61,560 - $3,240 = $58,320 (NOI)
Ok, we got the NOI, now what capitalization rate are you going to be using? Well that depends of the location, the tenants involved, and the type of property. It can really vary a lot, but anything under 6.5% would be unreasonable in my opinion. The right rate is the key to a good estimate. Look at the impact of different rates on estimates of value below:
$58,320 Divided by a rate of 5.0% equals a value of $1,166,400
$58,320 Divided by a rate of 6.5% equals a value of $897,231
$58,320 Divided by a rate of 7.5% equals a value of $777,600
$58,320 Divided by a rate of 8.5% equals a value of $686,118
$58,320 Divided by a rate of 9.5% equals a value of $613,895
P.S: This is just a rough example. You need more information than what you have to estimate the value through the income approach.
Wow. that helps a lot. The only thing is am unclear about is how to determine that 5-9% cap rate. Do I understand that it is based on how affluent the area is, how trustworthy the tenants, how many vacancies are in the area?
Once I can understand this part im on my way....btw that's .90 cent per square foot per month....
THANKS for your help on this, I will recommend this site to everyone (I know your groaning right now :-)
rookie
Once I can understand this part im on my way....btw that's .90 cent per square foot per month....
THANKS for your help on this, I will recommend this site to everyone (I know your groaning right now :-)
rookie
QUOTE(loanuniverse @ Jan 12 2006, 04:21 PM)
In order to use capitalization rate you need something to apply it to. The number that you are looking for is the Net Operating Income or NOI. Once you have that it is divided by the cap rate to get an estimate of value.
NOI is computed by deducting operating expenses from rental income. Therefore, the first step is to figure out how much is the rental income.
We know that the property has 6,000 Sq. Ft. and that the rent is $0.90 per Sq. Ft. However, there is something not right with that $0.90 per Sq. Ft. number. It is just too small! Rental rates per Sq. Ft. are quoted on a yearly basis and even warehouse space located in the worst of neighborhoods goes for at least a couple of dollars per year. Lets say that they quoted you the rental rate per month, then you would do $0.90 X 12 = $10.80 per Sq. Ft.
The potential gross income is then easy to calculate 6,000 X $10.80 = $64,800
However, potential gross income is not the same as actual income. You really need to know the actual vacancy rate of the property and the vacancy rate for similar properties in the neighborhood. A trick of the trade is to assume a 5% vacancy rate as natural and just deduct it from potential income. That would mean that you would end up with a certain amount of revenue at an "stabilized" state. But if your building is not 95% occupied then you have to account for the expenses and time needed to get the building stabilized. For the purposes of this example, lets assume that the building is stabilized. Then your income would be:
$64,800 - $3,240 = $61,560
Next step is figuring out the expenses. If leases are triple net then it means that the tenants pay for most of the expenses. However there are a few expenses that might need to be taken care of by you for different reasons. Lets be gentle and say that an additional $3,240 in expenses will be incurred.
$61,560 - $3,240 = $58,320 (NOI)
Ok, we got the NOI, now what capitalization rate are you going to be using? Well that depends of the location, the tenants involved, and the type of property. It can really vary a lot, but anything under 6.5% would be unreasonable in my opinion. The right rate is the key to a good estimate. Look at the impact of different rates on estimates of value below:
$58,320 Divided by a rate of 5.0% equals a value of $1,166,400
$58,320 Divided by a rate of 6.5% equals a value of $897,231
$58,320 Divided by a rate of 7.5% equals a value of $777,600
$58,320 Divided by a rate of 8.5% equals a value of $686,118
$58,320 Divided by a rate of 9.5% equals a value of $613,895
P.S: This is just a rough example. You need more information than what you have to estimate the value through the income approach.
NOI is computed by deducting operating expenses from rental income. Therefore, the first step is to figure out how much is the rental income.
We know that the property has 6,000 Sq. Ft. and that the rent is $0.90 per Sq. Ft. However, there is something not right with that $0.90 per Sq. Ft. number. It is just too small! Rental rates per Sq. Ft. are quoted on a yearly basis and even warehouse space located in the worst of neighborhoods goes for at least a couple of dollars per year. Lets say that they quoted you the rental rate per month, then you would do $0.90 X 12 = $10.80 per Sq. Ft.
The potential gross income is then easy to calculate 6,000 X $10.80 = $64,800
However, potential gross income is not the same as actual income. You really need to know the actual vacancy rate of the property and the vacancy rate for similar properties in the neighborhood. A trick of the trade is to assume a 5% vacancy rate as natural and just deduct it from potential income. That would mean that you would end up with a certain amount of revenue at an "stabilized" state. But if your building is not 95% occupied then you have to account for the expenses and time needed to get the building stabilized. For the purposes of this example, lets assume that the building is stabilized. Then your income would be:
$64,800 - $3,240 = $61,560
Next step is figuring out the expenses. If leases are triple net then it means that the tenants pay for most of the expenses. However there are a few expenses that might need to be taken care of by you for different reasons. Lets be gentle and say that an additional $3,240 in expenses will be incurred.
$61,560 - $3,240 = $58,320 (NOI)
Ok, we got the NOI, now what capitalization rate are you going to be using? Well that depends of the location, the tenants involved, and the type of property. It can really vary a lot, but anything under 6.5% would be unreasonable in my opinion. The right rate is the key to a good estimate. Look at the impact of different rates on estimates of value below:
$58,320 Divided by a rate of 5.0% equals a value of $1,166,400
$58,320 Divided by a rate of 6.5% equals a value of $897,231
$58,320 Divided by a rate of 7.5% equals a value of $777,600
$58,320 Divided by a rate of 8.5% equals a value of $686,118
$58,320 Divided by a rate of 9.5% equals a value of $613,895
P.S: This is just a rough example. You need more information than what you have to estimate the value through the income approach.
The right cap rate is a function of the market primarily. You can argue until your face turns blue with the seller that the historical cap rate for a particular type of property has been 9%. But if similar properties are being sold at 6.5% cap rate, it will not make a difference.
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