How do you value vacant commercial space?
For example - is there’s a shopping strip being sold with 3/5 spaces vacant, what is your approach in valuation? 100% Occupancy minus leasing costs, holding costs and TI?
[{"id": "fdkxnqp", "text": "Depends on the market and what your assumptions are. And also depends on if you are buying or selling it. \n\nHow old is the space? What is the credit of the existing tenants? What are the demographics of the area? What are the traffic counts? Is it on a corner? \n\nIn a good market, you will assume that there will be minimal downtime and you can expect market rents, so those will juice your proforma. \n\nIn a bad market, you pass on this space unless there is something else you see here. \n\nAn appraiser would do replacement cost or land value since I would assume trying to get the property value using capitalization rate would be too low.", "replies": [{"id": "fdkyfh4", "text": "thanks! But if a property is based on income (NOI) and the space is only 50% occupied, how do you come up with a proper valuation on a space that isn\u2019t too desirable which would take 6 months to lease up? Account for all the costs? And subtract that from the full market value?", "replies": [{"id": "fdl3zj8", "text": "A starting point would be in place NOI. That is what the property is generating today. You can create a proforma with market rents, but as others stated be sure to deduct all the OpEx and capex items that will hit the proforma.\n\nIf you believe you can create some value it may be a good buy opportunity. OR it could sit vacant forever and that is why the current landlord is selling.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fdkyjry", "text": "Use market occupancy and rent to reach a stable valuation.  Deduct leasing costs (ti, commissions, vacancy to lease).  Deduct costs to get existing lease to market or compensate if needed.  Deduct entrepreneurial incentive (this is how much you want to get paid, or is reasonable to get paid, to fix this property).\n\nThats what its worth basically", "replies": [{"id": "fdl82eb", "text": "I wanted to expand on this a bit because its actually a really really good question (Its one I frequently get, or hear unsolicited opinions on which lets me quickly figure out who are serious/experienced investors and who are not).  \n\nFor some of the other methods mentioned here:\n\nComparables: I mean if you can find a good set of comps that are very similar with the same expense profiles, similar occupancy, locations, quality etc I'd certainly look at that.  I'd certainly look at stable $/SF for my stable valuation too and make sure it confirms my cap rate analysis.  The odds of you doing a comparative analysis on a distressed strip center to any degree of accuracy are pretty low though.  Use that type of thing as a confirmation of your fiscal analysis.  If you did manage to find a lot of good 60% occupied strip comps maybe that says something about the market vacancy you want to consider.  One large problem you run into with retail vacancy comps too is they shift from investment buyers to owner user buyers.  Owner/users typically pay more as they remove uncertainty and vacancy concerns and have other business objectives outside of RE.\n\nReplacement cost:  This might kinda work if its a brand new center.  Event then though there are so many things that go into this.  For replacement cost to make any sense you basically have to be in a situation where there is market demand to build a similar property, land available, and investor demand.  In that situation, you also are going to have to adjust for your property being existing for being built in the future.  On the flip side there are tons of structures out there you'd never rebuild if required, and they still have value of course, it is just less than the reconstruction value.  I'd not really worry about this at all outside of some very limited circumstances, which there are no reasons to believe exists here.\n\nIRR/DCF: you would do this if this were larger.  I'm assuming this is a small neighborhood type strip with 5 spaces.  In that type of property you typically introduce more garbage than anything when you DCF it out.  If the 5 spaces are a 300 SF grocery, and 4 50-150k SF big boxes then yes I would do a DCF on this along with a ton of what if analysis to figure out my stress points and what can happen here that makes this a huge win or an utter disaster and assess my risk as needed.\n\nMost beginning investors see every rule of thumb they have break on these and jump to \"well I'm not paying for potential, I only pay for in place income!\".  That is a huge mistake.  It just means you will be wasting your time and submitting an offer below what the more seasoned investors submit who know how to accurately assess this.  Likewise, if you look at this as a stable property you will over pay.  I'll discuss all day long about leasing time and other assumptions buyers are using here to do their valuations, if it comes down to \"its 60% occupied so I'm going to pay 60% of its stable value\" you are wasting your time along with the sellers/brokers/etc.\n\nAlso depending on more details distressed properties typically do not get as good of financing terms as stable ones, and there is more risk there, so compensate for that.  \n\nOne method I have seen but its fairly rare, is doing a split cap analysis too where you cap the in place income at a lower rate to essentially set a safe mark.  That is typically done as a verification method though and a kinda backstop worse case scenerio.  How that basically works is say the center should be a 7.5 cap stable but its 60% occupied as you say and the market occupancy is say 85%.  you may consider holding at 60% to be very low risk, lower risk than market risk on a fully occupied center.  You may use 5% on the in place.  That kind of analysis isn't very common though and as I said I wouldn't use that as a primary valuation, more a what if/risk assessment type valuation.", "replies": [], "depth": 2}], "depth": 1}, {"id": "fdkykyt", "text": "Usually, CRE properties are valued by the following formula: NOI / Cap Rate. \n\nProfessional investors use the NOI and an IRR to determine the price. \n\nFor vacant property, my guess would be to price it for it's best use. Are you planning to demolish the place and build something new? Are you planning to renovate the property and bring tenants? \n\nI'd talk to appraisers and brokers to get a better answer for the particular property and objectives you have in mind.", "replies": [], "depth": 1}, {"id": "fdkymr8", "text": "Replacement cost and/or comps for other vacant retail.", "replies": [], "depth": 1}, {"id": "fdl7n6x", "text": "For valuation, there isn't a single answer so think about what makes sense. If it has a lot of vacancy, a discounted cash flows analysis probably makes sense to show it progressing up to stabilization.  If it's just a little, might make more sense to do a regular direct capitalization as if stabilized and deduct the leasing costs and loss of rent like you noted. Ultimately, how would the likely buyers frame it? If it would be sophisticated investors with big spreadsheets, DCF may win. If it's smaller, older, in smaller community, they might not focus so hard about the vacancy. I had one buyer who had 30 out of 50 apartments even useful; the rest were in various conditions of renovation. I asked how he priced it: 10% cap rate. I asked if that was for in-place income or when stabilized, and he said when stabilized. \"Great, so what would you use for in-place income?\" I asked. 10%. Even though 40% of the units weren't even renovated yet, he thought it should be the same cap rate for both. It's not directly same as your situation, but you can see how some people are less detailed in their analysis. Some others may figure the price based on 60% occupancy and \"round up\" for being able to lease the rest later.", "replies": [], "depth": 1}, {"id": "fdlheyt", "text": "You want to calculate the In place NOI but you would not capitalize it.  You would then calculate the NOI starting with potential gross income and then use market vacancy and expenses to get a stabilized NOI that you would then use market cap rate to value the building as stabilized.  To add to u/NumNumLobster analysis you would also deduct the present value of rent you are not collecting and you would also adjust for lower variable expenses that you will not have until you lease up.\n\n&amp;#x200B;\n\nToo many novices think you want to capitalize the in place NOI when there is excess vacancy but that grossly overstates the value of the lease up costs.", "replies": [{"id": "fec3v5r", "text": "Removed. Realized after the property is partially occupied.", "replies": [{"id": "fecjz5k", "text": "You would value it the same way if it was 100% vacant.", "replies": [{"id": "fedl5g7", "text": "Not true. There is no cap rate on a property that generates no revenue.", "replies": [{"id": "fee3ts5", "text": "It is the market cap rate comps that is used to value a vacant property.   The below the line adjustments affects the price not the cap rate.  Remember, NOI starts with PGI, every building has PGI.  That is how you value any building that has excess vacancy whether it be 20% or 100%.", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fdloor4", "text": "(Odds of leasing it * Market Rental Rate) - Market concessions and cost of lease up * cap rate", "replies": [], "depth": 1}, {"id": "fdm3he3", "text": "Levered IRR to account for the costs, timing and risk. Solve for a high teens return", "replies": [], "depth": 1}]