Evaluating/Valuing an investment property
Whenever you come across a potential investment opportunity, either at work or for yourself, how do you initially look into a property and what financial metrics do you look at when deciding if the property is a good buy. I’m aware of cap rates, CoC, IRR etc. But if you’re a long term holder, what would be the most ideal way to value a building and why so?


[{"id": "duwp5yw", "text": "Look at the spread between cap rate and interest rates for relative valuation.  \n\nBut there are many other factors.  If it's an infill location and in a market with population growth (more people=more potential demand). Then it's probably worth taking that lower valuation since there are more barriers to entry which may help with rent growth.\n\nIRR is honestly BS and primarily driven by your forecasted sale price.  You could do a 30 year DCF model and try to locate your NPV (if the building will last that long). People can often be delusional about the useful like of their buildings.  It's really important to consider where this building will be in 30 to 50 years.  If it's office your going to need a lot of power in the future to handle all the computers and old buildings don't have enough as is.  If it's industrial, it should be tilt up with high clear.  If it's retail then it has to be good quality and not in an overbuilt area.  \n\nDon't count on rent growth at all for your financial success, it's not guaranteed at all.", "replies": [{"id": "e1v9ieh", "text": "&gt; Look at the spread between cap rate and interest rates for relative valuation.\n\nWhat would that tell you?", "replies": [{"id": "e1w9yc8", "text": "It would let you know if debt will increase or decrease your return.  (Positive or negative financial leverage)\n\nIf your return is below your borrowing cost your just speculating in price appreciation (risky)", "replies": [{"id": "e1wpk2f", "text": "Interest rates are pretty much uniform across the country.  Cap rates vary greatly across the country.  Cap rates are not a return metric.  Cap rates measure the demand for NOI.  The larger the spread between cap rate and the interest rate probably means the property is less profitable.", "replies": [{"id": "e1wshrq", "text": "There are so many factors to get into.  I'm really talking about a similar quality building accross the board.  Obviously if your buying at an 8 cap there is something inherently more risky about the property (above market rent, obsolete building, bad market, etc.).  I only deal in good quality property.  But if your buying at a 4 cap and borrowing at 4.5% your just speculating that rents will go up and or someone dumber than you will buy it for more.\n\nIf the spread between your interest rate and cap rate is negative you'll need to go 40%+ equity just to be cash flow positive.\n\nInterest rates and cap rates vary similarly accross the US for similar product.  In LA your getting lower interest rates and cap rates than a turtiary market for instance.\n\nIf you have a decent building at a 6cap and your borrowing at 5%, 80% down your cash on cash is about 10%.  If your at a 4 cap you probably couldn't even borrow 80% on a primary but if you could you will be at a 0% cash on cash return.  Then commissions will be coming out of pocket.", "replies": [{"id": "e1x7xmu", "text": "&gt; Interest rates and cap rates vary similarly across the US for similar product.  In LA your getting lower interest rates and cap rates than a turtiary market for instance.\n\nYou don't think interest rates are the same across the country?\n", "replies": [{"id": "e1x7xps", "text": "Hey, Honobob, just a quick heads-up:  \n**accross** is actually spelled **across**. You can remember it by **one c**.  \nHave a nice day!\n\n^^^^The ^^^^parent ^^^^commenter ^^^^can ^^^^reply ^^^^with ^^^^'delete' ^^^^to ^^^^delete ^^^^this ^^^^comment.", "replies": [], "depth": 7}, {"id": "e27dao3", "text": "I guess it depends where you are getting your money and what your buying.  Life companies will get really competitive and still give you rates close to 4%, possibly less, for good quality product in major markets.  Bank lending which is more typical is probably more consistent across the US but you will still pay a little more outside of major markets or with sub-par products. ", "replies": [], "depth": 7}], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "duwx9ss", "text": "The primary metric is always cap rate.  \nYou really want to dig into the NOI and make sure all the information is as it is being represented. From there, look at how much upside might be in the property - are the rents below market and can they be raised? Can any major expenses be reduced? Any other untapped potential?  Also, make sure the building is well located and that no coming changes (political, infrastructure, etc.) will have a negative impact on the property.\n\nBefore purchase, look at your financing and figure cash-on-cash return. As long as your interest rate is less than the cap rate, leverage will only enhance the return. \n", "replies": [{"id": "duwxc4i", "text": "Very true. Exactly how I think as well. ", "replies": [], "depth": 2}, {"id": "dvgws2a", "text": "How do you figure that interest rate needs to be lower than cap rate in order to be accretive?", "replies": [{"id": "dvhex7r", "text": "Holy cow, thank you for making me think about that. That's way too general a statement for something with too many variables to just be completely true, isn't it? \n\nWhile it is true that the loan interest rate needs to be less than the cap rate to enhance the cash on cash return, it's certainly not true that *any* lower rate will have that effect. With an interest only loan, a .01% difference will improve the return, but with most amortized loans the difference often needs to be at least a full point, if not almost two points - depending on other variables.  \n\nI should avoid throwing out a blanket statement like that as if it were an absolute truth. I've struck that part of the comment.", "replies": [], "depth": 3}], "depth": 2}, {"id": "e1v9kcy", "text": "&gt; The primary metric is always cap rate.\n\nWhy would that be?", "replies": [{"id": "e1vfu88", "text": "Cap rate is the most basic measure for comparison of different investment properties. It takes the financing variables that can influence cash-on-cash return and IRR out of the equation. I'm not saying you don't look at cash-on-cash, etc., just that you generally look at cap rates first. If that looks good, then you go into more detailed analyses.", "replies": [{"id": "e1vhfg5", "text": "OK, how would a cap rate on a property offered for sale LOOK good?  How would you even figure a cap rate without a sales price?  So what cap rate are you looking at, first?", "replies": [{"id": "e1vwtkj", "text": "&gt;OK, how would a cap rate on a property offered for sale LOOK good? \n\nCap rate is essentially a rate of return measure, so as a buyer, other things being equal, higher cap rates are better than low cap rates. Other considerations come into play, such as quality of tenants, length of leases, the local market (basically measures of risk). High is generally \"good.\"\n\n&gt;How would you even figure a cap rate without a sales price? \n\nTechnically, you wouldn't, since cap rate = NOI/price. However, if you make cap rate into a required rate of return, you then call it a 'discount rate,' and you can use your target discount rate to figure what you'd be willing to pay for a property. If a property has a $100k NOI and you want a 10% return (unleveraged), then you'd be willing to pay $1 million for the property. \n\n&gt;So what cap rate are you looking at, first?\n\nI don't understand what you're asking here. ", "replies": [{"id": "e1wq12h", "text": "&gt; OK, how would a cap rate on a property offered for sale LOOK good?\n&gt; Cap rate is essentially a rate of return measure, so as a buyer, other things being equal, higher cap rates are better than low cap rates. Other considerations come into play, such as quality of tenants, length of leases, the local market (basically measures of risk). High is generally \"good.\"\n\nCap rates measure the DEMAND for NOI.  It is not a \"return\" metric.  If you are in a 10 cap market and can buy at 11 then thank your Grandma for selling below market to her favorite grand kid but that's a one off deal.  HIGH CAP RATE MEANS LOW DEMAND FOR NOI.", "replies": [{"id": "e1wtdzs", "text": "&gt; Cap rates measure the DEMAND for NOI. It is not a \"return\" metric.\n\nActually, it's both.  \nThe demand side of it you're talking about is a reflection of how real estate measures up relative to other investment options. Not so much a demand for NOI (though I see what you're saying), but a demand for return. If Stocks are returning 12% and bonds are at 7%, real estate (cap rates) might be somewhere in between, depending on the perceived risk in the market at that time. ", "replies": [{"id": "e260bmv", "text": "https://www.reddit.com/user/KyOatey   Crickets?  ", "replies": [], "depth": 8}], "depth": 7}], "depth": 6}, {"id": "e21mhas", "text": "&gt;  However, if you make cap rate into a required rate of return, you then call it a 'discount rate,' and you can use your target discount rate to figure what you'd be willing to pay for a property. If a property has a $100k NOI and you want a 10% return (unleveraged), then you'd be willing to pay $1 million for the property.\n\n\nSo here is the FLAW in you statement saying a cap rate is a \"yield\".  In you example you have an investor looking for a \"yield\" of 10% so he is paying $1,000,000 for $100,000 NOI.  Now you think he is making 10%.  But when used correctly a cap rate is a valuation metric that measures the demand for NOI. Now in your example you just paid $1,000,000.  I looked for cap rate comps in the exact same market and found out that the market is buying NOI at 15% cap rate.  So I make my offer for the exact same NOI that you are buying but since I am educated about cap rates I ONLY pay $666,667!  How does that 10% FAKE \"yield\" seem to you now?\n  ", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}, {"id": "e1x84fm", "text": "&gt; Cap rate is the most basic measure for comparison of different investment properties.\n\nExactly how would you use cap rates to compare different investment properties?  I've been asking this question on the internets for over 10 years and NO one has been able to answer it.  Can you?", "replies": [{"id": "e1xjj1v", "text": "Property A: 6.0% Cap  \nProperty B: 6.5% Cap  \nProperty C: 7.5% Cap\n\nThere, I compared them. You're sure putting a lot of effort into trolling a post from 4 months ago. \n", "replies": [{"id": "e1ylocb", "text": "Why would you be comparing properties that have sold?  That is wasted effort.", "replies": [{"id": "e1z8lfo", "text": "You do realize you can figure a cap rate on either the previous year's income, or on projected income, don't you?  \nAnd if you're going to tell me \"but that isn't a cap rate,\" then tell me what you'd call it instead.", "replies": [{"id": "e1zejwr", "text": "What are you using for V?", "replies": [], "depth": 8}], "depth": 7}], "depth": 6}, {"id": "e21byuy", "text": "Property A: 6.0% Cap   $50,000 NOI purchased at $833,333.\nProperty B: 6.5% Cap   $50,000 NOI purchased at $769,231.\nProperty C: 7.5% Cap   $50,000 NOI purchased at $666,667.\n\nWhere's the comparability?  ", "replies": [{"id": "e21ixyx", "text": "If everything else is equal, buy the 7.5% cap.\n\nFor a better understanding, go pay someone to educate you about cap rates: https://www.ccim.com", "replies": [{"id": "e21jqrs", "text": "&gt; If everything else is equal, buy the 7.5% cap.\n\nThat 7.5% cap was created when someone else bought it.  You need a sales price to calculate a cap rate.  Anyone on a commercial real estate sub should have that basic understanding.  Also those three sales would NOT be equal and sell at a spread of $666,667 to $833,333!  Nothing you have said gives me any indication that you are familiar with commercial real property valuation.  I just want to make sure anyone interested can get the facts.", "replies": [{"id": "e221gu9", "text": "Alternatively, you could take your great knowledge on the ins and outs of cap rates and see about getting hired to teach CCIM classes. \n\nMy guess is you won't get the job.  \n\n", "replies": [{"id": "e22j4to", "text": "No desire to teach, I focus on my investments.  I am a qualified expert witness for the state of CA to testify on valuations.  That and my experience in the valuation of over $40,000,000,000  of commercial properties probably would over qualify me.\n\nHowever when I see scammers and blowhards spouting off incorrect information I'm happy to educate or expose them.  See, I saved you the cost of the course.", "replies": [{"id": "e22jf3x", "text": "I'm calling 'big hat no cattle' on you buddy. Plus, whoever taught you about cap rates left you quite misguided (with a lot of confidence though). Best of luck to you.", "replies": [{"id": "e22kxic", "text": "That is all you do, name call and attack.  I can answer any cap rate question you pose.  You have been evasive in responding.  You must be a scammer or completely stupid.", "replies": [{"id": "e22l728", "text": "I tried engaging you for a while, but you're obviously an odd sort of troll. I'm done.", "replies": [{"id": "e22lqnu", "text": "Don't go away mad, just go away.  Get educated on valuations and then come back and engage.  Learn some etiquette also.", "replies": [], "depth": 14}], "depth": 13}], "depth": 12}, {"id": "e23c0ss", "text": "https://www.appraisalinstitute.org/rates-and-ratios-used-in-the-income-capitalization-approach/\nA place to start.", "replies": [], "depth": 12}], "depth": 11}], "depth": 10}], "depth": 9}], "depth": 8}], "depth": 7}], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}]