Valuation of Leased Vs. Vacant Properties
Lets say you have two identical properties, the only difference is that one is leased and the other is not.  How much more (on a % basis) would you expect to pay for the leased property?  Assuming there is a good amount of life left on the lease.  Is there a formula to help calculate this?
[{"id": "dyfzkkt", "text": "Everything is our industry is market based.  I work in acquisitions at a real estate private equity firm that does value-add office/industrial deals ($5MM - $40MM).  Typically we look for properties that are 50%-70% occupied.  We look at sales comps (on a per square foot basis) for similar properties in the area.  Then try to extrapolate them to the property, making adjustments that we feel make sense.  I\u2019ve never seen my firm use a cap rate for an acquisition.  It\u2019s important to remember that as the end of the day the property is worth whatever someone is willing to pay for it.  You can do all the arduous DCF models you want, but comparable sales is going to best reflect what someone is willing to pay.\n\nTo answer your question, it is market based.  Fully stabilized class B office space in Charlotte, NC is probably going for $130/sqft or higher.  With some vacancy (say 30%), depending on the property, I\u2019ve seen class B office space in the same market go for $70/sqft.  There is not a formula to calculate this, it is market driven and you\u2019ll probably need access to CoStar if you don\u2019t want to spend hours digging through county records.", "replies": [{"id": "dyg1ihd", "text": "Do you believe sales comparison is more accurate representation of value than any income approach - dcf or even direct cap? I get what you\u2019re saying that sales takes into account what someone ACTUALLY pays for it and then you make your adjustments there...but if a building is income generating, the opinion of value should be based on that in my opinion.\n\nTo continue answering OPs question, you have to consider the costs to stabilize - leasing costs, TIs, etc. These all factor into a lower valuation.", "replies": [{"id": "dyg3vjo", "text": "I\u2019m not in appraisal, and the \u201cadjustment\u201d we make are not your typically up/down adjustments made in appraisal.  We are not trying to pay FMV, we are trying to pay the least amount possible, because obviously that is going to significantly increase our returns and promote.  If we know that the roof is going to need to be replaced during our holding period, and it\u2019s going to cost $800,000, you better believe we are bringing that to the negotiating table and that we are trying to get a bigger than $800,000 haircut.\n\nFrankly, in all the acquisitions I\u2019ve seen, and everyone else I talk to in acquisitions, for value-add deals you buy at a per sqft basis and sell at a cap rate.  If the deal is stabilized you use a cap rate.  If the deal is a vacant building, or has some significant level of vacancy, it is really hard to justify using a cap rate or DCF.\n\nYou\u2019re also missing a big part of the puzzle.  In theory, the sales comps captures the market rates.\n\nLet me also ask you this.  How would you go about finding an accurate cap rate for the comparable submarket?  It is nearly impossible to get accurate NOI numbers on comparable buildings.  Sure, you may have some data source like CoStar to pull that from, but when I\u2019m underwriting the acquisition of a $35 million dollar office building I\u2019m sure as hell not trusting CoStar.  If the NOI is 2.5MM, the difference between a 7 cap and a 7.25 cap is almost $1.8 million dollars.", "replies": [{"id": "dyg797f", "text": "To find appropriate cap rates you have to find closed sales that sold to investors. You're right, you can't trust CoStar's numbers to be accurate, so I always call the parties involved in the transactions to have them confirm the NOI, vacancy in the building, sale price, how much deferred maintenance, length of term remaining (if single-tenant), etc. But we really only use Sales Comparison Approach to identify a cap rate. I'm doing appraisals for bank loans though, and I understand each investor has different criteria for each deal.", "replies": [{"id": "dygaozs", "text": "http://www.korpaczra.com/cap-rate-studies/   Here's a reliable source for third party sales analysis that investors use.  ", "replies": [], "depth": 5}, {"id": "dygbtmk", "text": "Completely agree.", "replies": [], "depth": 5}], "depth": 4}, {"id": "dygwocp", "text": "&gt; Frankly, in all the acquisitions I\u2019ve seen, and everyone else I talk to in acquisitions, for value-add deals you buy at a per sqft basis and sell at a cap rate.\n\nI know you do mainly value add- but could you approach this as if its full on development- The spread between exit pricing and acquisition yield on cost. So, if you think NOI you can get (based on market data) is $5 and total acq cost including cap ex is $80, your yield on cost on acquisition is 6.25%. Stabilized buildings are being sold at a 5 cap, so if you think you will complete the cap ex, get it stabilized and sell it at a 5 cap, then your profit is essentially the 125 basis point spread.  Is this approach valid? This is closer to the cap rate approach that the other commenter was referring to. ", "replies": [{"id": "dygzvot", "text": "Yea that\u2019s a valid approach.  That\u2019s actually exactly what we do.  We do some capex on every deal.  I have my Masters of Real Estate Development, so I\u2019m pretty familiar with ground up stuff as well.", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}, {"id": "dygb9d7", "text": "Direct sales comparison is the more accurate approach to value.  When a property is encumbered by below and/or above market long term leases you cannot use direct sales comparison.  Identical buildings can have NOI's of $500,000 and $2,000,000.  You would not pay the same for those buildings.  Direct capitalization would be used to value the NOI, not the building.  This is a less accurate valuation method.  It amazes me when I see the little 4plex investor trying to talk cap rates without a clue.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "dyg520f", "text": "There\u2019s not really a rule of thumb but an investor would look at how long and how much will it cost to bring the vacant property to stabilization. That includes your expenses on vacant area during absorption, potential tenant improvement costs, marketing &amp; commissions, etc.  Basically figure out how much it would be worth if stabilized and then figure out how much it will cost to get there. That\u2019s more or less the discount that\u2019s applied to the vacant property.", "replies": [], "depth": 1}, {"id": "dyg6sw3", "text": "One thing you need to consider is who the buyer is. In the southern CA industrial market, owner/users will pay approximately 15% (although this number is shrinking) more than an investor will because the asset is another tool in their business. Investors have to make a profit from the income from the real estate, whereas owner/users do not.\n\nHere's a scenario. In north Orange County, CA, you have a 10,000 SF single-tenant industrial building. In doing an appraisal for an acquisition, a bank requires the appraiser to perform both an Income Approach and a Sales Comparison Approach. There is typically a spread of 5-15% between the two approaches. The bank wants to know who the most likely buyer is. Therefore, if the property is leased, the most likely buyer is an investor, and more weight is given to the Income Approach. If the property is vacant, the most likely buyer is an owner/user, and more weight is given to the Sales Comparison Approach. \n\nIf you are an investor, and you are deciding which building to buy, vacant vs leased, you would want to look at a few things. You would need to do a rent survey and determine what market rent is for the property. Then see if the tenant in the leased building is paying market rent or not. In the vacant building, you would need to figure out how long it would take to stabilize (lease the property) and the costs associated with stabilization.", "replies": [], "depth": 1}, {"id": "dyg8nv7", "text": "For properties encumbered by long term above or below market leases you would use the income approach.  The vacant building would use current market rents and NOI would be calculated as if the property was operating to market occupancy.  \nThis would give you the value of the building using direct capitalization.  THEN you would discount this value by the lost rent income until the property is leased up and the costs of leasing up the property such as leasing commissions, TI allowances, etc.  But you would also consider that your variable expenses will probably be less during the possible multiple year lease up period.  Generally all these deductions would be computed as the present value and deducted as a below the line adjustment.  You are also taking a risk that market rents and demand could change over the lease up period so you would want to account for that in your final value determination.  ", "replies": [], "depth": 1}, {"id": "dyrm1h9", "text": "This is local market dependent. If rents are rising in an area quickly, a vacant building can actually be more valuable than one with a paying tenant with a lot of lease time yet.", "replies": [], "depth": 1}]