Help on explaining property valuation to my friend
Alright, here's the basis on valuing the property to make a financial statement to a bank.  

It was appraised at 1.1m about 6 months ago. Single tenant industrial on a double net lease (he pays taxes). Loan is at 750,000  The lease is 7,000 / month for 10 years with 2, 5 year extensions that automatically happens if no one objects or changes things. 2 years into initial contract.

He wants to say the asset is the building value plus the lease value and is adding in the 2, 5 year extensions.  He's not counting anything against the net value of the building except the loan.  I don't think he's doing it right and wanted to check with yall and see what you think plus any idea how to explain it to him better would be great.  Thank you
[{"id": "czjdko5", "text": "The extensions arguably have no bearing on the value. With an asset like this you should just cap the NOI. Subtract the annual taxes from the annual income of 84,000 and then divide by an appropriate cap rate. For example: if taxes are $10,000 then divide 74,000 by 6.75% and boom, value of $1.1M. I made up that cap rate, but it gets us to the right value. If you know any brokers in your market they can give you a ballpark cap rate range. Also, the appraiser probably used a cap rate in their report.\n\n\nReally, since it was appraised at $1.1M just 6 months ago, I'd say that is probably the value.  Maybe a little appreciation depending on the market.", "replies": [{"id": "czkluw2", "text": "Ok, so I get that for the value of the property. Does capping the noi also replace the rent value and just give you a total market value for the property in current status?", "replies": [{"id": "czl0g2x", "text": "That's right. It operates much the same way as the dividend growth model of valuing a stock if you are familiar with that.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "czjrkbj", "text": "Your friend is kind of right in the taking a kind of complicated topic and over simplying it too much to where it is wrong way.\n\nLook at it like this, you no longer have the use of the property.  What you do have is a stream of 7k month lease payments, and you will get the property back some day.  You also have some expenses.  \n\nNow lets say you loan me 10.  How much interest would you charge me if I paid it back this month?  What if I paid you back in 10 years?  This works the same way.  The first 7k payment (minus expenses) would be pretty much worth whatever it is.  The one 10 years from now?  Not so much.  You discount all that back to what it is worth today, and add it up.  Now we have a building to deal with.  Figure out what its worth in 10 years, and discount that back to now.  Add that in too.  The extensions would really decrease the value of the property as you would only use them if market rate were higher.  So you can make an adjustment for that.  \n\nOr you can do it the easy way and take the noi and capitalize that like /u/not_last_place said, which is typically how these things are done until you get to some complex properties.  \n\nOr you can do it the real real easy way and figure if nothing drastic changed in the last 6 months that appraisal is probably still be damn accurate.  \n", "replies": [{"id": "czklz0i", "text": "So doing a discounted cash flow analysis and adding building discounted value together would also be the more difficult but still an option", "replies": [{"id": "czmghuo", "text": "it's way too much work for your issue. The income method explained above is easier to do &amp; explain. ", "replies": [], "depth": 3}], "depth": 2}, {"id": "d0cv5yj", "text": "This is by far the best answer in the thread. \n\nValuing industrial and net leased buildings matters far more than a cap rate, although for similar tenants a cap rate will be similar and a good comparison tool - a simplification of relative value. \n\nLet's say GE signs a lease with you compared to Uncle Ruckus' Oil Old Rigs. If you only used an NOI and cap rate, you might value these the same, and that would be dumb. \n\nLet's say you have a GE lease in a good area, below market rent, and a new building compared to oil tankers leaking into your ground with a bankrupt alcoholic tenant in the hood at an above market rent that you could never resign another tenant at. Want to value these the same with a cap rate? \n\nHere's what to do: a little of both analyses. Compare your cap rated to similar buildings and lease structures if you have a fairly common use, but consider the residual value compared to others; the ease of sale / liquidity as well as price people will be willing to pay for what your asset will be in 20 years at least end or say, in 10 years at the end of your financing and when someone else could get a 10 year loan to match the lease term. Use the above extreme hypothetical to help your compare, and try not to buy the Uncle Ruckus building. ", "replies": [], "depth": 2}], "depth": 1}, {"id": "czjx7q7", "text": "That's not the way to value a building based on rent.  As others said, the easiest thing to do is just capitalize one year NOI.  If you insist on valuing the income stream, the way to do it is a discounted cash flow (DCF) analysis.  The idea of that is, a dollar next year is worth less (i.e. it is \"discounted\") than a dollar today.  The value IS the value of the income streams, plus the value of the building, but the trick is, each year's income is worth less (in present value) than the year before, and the benefits of owning the building don't come until the lease is over.\n\nLet's say the discount rate is 10%, completely arbitrarily.  That means you take this year's cash flows (net, after taxes, insurance, maintenance, management, and reimbursements), discounted to the end of the year, and multiply by by .9091 (which is 1 divided by 1.1).  Then you take year 2, multiply by .8264 (1 divided by 1.1 squared).  And so on, for each year of the 10 year lease.\n\nNo way does that extension mean anything.  If the rent is flat for 10 years, there is no way it will be market in 2026, it will have to renegotiate.  Ignore it.\n\nAt the end of ten years, you then get the building back (reversion).  Pretend it appreciates 3% per year.  So it will be worth $1,100,000 X (1.03^10) = $1,562,380.  But that value is discounted as well; the present value of that reversion, ten years in the future, is only 0.3855 of its anticipated future.\n\nPut it all together, here is a ten-year [DCF:](http://imgur.com/8rElHqa)\n \nThe number on the lower right is the sum of all the discounted present values.  It incorporates a lot of wild assumptions, so it's not really meaningful, but basically it's a check on your friend's assumptions, showing the value of the building doesn't change whether you use a cap rate, or a DCF, as long as you get the math right.", "replies": [{"id": "czkm0ma", "text": "Thank you so much for the chart, that helps a ton", "replies": [{"id": "czmgl19", "text": "this is a good explanation and model, but you won't get a 10% discount rate. I haven't had my nose in an appraisal for a couple of years, but IIRC it's usually closer to CPI or treasury rates. ", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "czxrsdm", "text": "If you have a 6 month old appraisal just use that. \"building value plus the lease value\" that makes no sense. Either you use an income capitalization approach, which is applying the cap rate to the income, to arrive at the value (as I'm sure the appraiser did!) - or you look at the Cost of building the structure plus value of the land (which is going to be way way less).", "replies": [], "depth": 1}]