A couple of years ago, a few people asked me how to determine the value of commercial real estate. They weren't asking for a professional appraisal but just a quick, 'what do you think it's worth?' number. I wrote a short guide to how I have done it and I wanted to post it on here to get some conversation going that may help others. So, I'll paste it for you guys to analyze, rip apart, build on, etc... I really just want to see what others think about when it comes to putting a 'value' on a piece of commercial property.
I wrote this in about 5 minutes 2 years ago so it definitely needs improved upon. Have at it!
I think of price in this manner... How much would you pay for a shoe box that spits out 10 one-hundred dollar bills every month? The shoe box itself may only cost you 5 cents to replace but obviously it is worth much more than that because of the money it makes you.
I use the cap rate / ROI formula to determine how much return an owner can expect to get on their money. I actually look at several scenarios to determine if it is a good deal or not.
You must first make sure there are no deferred maintenance issues; leaky roofs, broken furnaces, other things that will suck away at your profits...
If you know how to determine NOI, you can use this in order to determine value. Take all of your gross rents and other income, add it all up. Then subtract ALL the things that will cost the owner except your debt payment: taxes, insurance, lawn care, snow removal, pest control, utilities (sometimes the owner get stuck with the trash, water, gas, and power bills).
Get this basic math done and then run your numbers through about 3 scenarios. First do 100% occupancy and no repairs, find your NOI. Second, do your gross rents at 93% occupied and $500 per year maintenance per unit, figure out your NOI on this. Third, Do your gross rents at 85% occupancy and $1,000 a year per unit maintenance, figure your NOI.
These number will tell you a lot about how good your deal is. I ran the numbers on our last building this way to make sure that our worst case (85% occupancy and $1,000 per unit per year maintenance) to find that I would still have plenty of cash reserves to pay the debt service and be able to make money.
As far as finding the value goes… It’s all a matter of what it’s worth to someone. To me, I don’t care about the cost of the shoe box as long as I’m making at least a 12% return on the investment. Use a cap rate evaluator to determine your value at 12%. Take the NOI’s that you just got from your calculations and then factor that by 12% (or 10% or whatever you want for return) this will give you the value based on that cap rate. Example: a building that costs $100,000 and has a NOI of $10,000 a year is a 10% cap rate. If I require a 12% return on my investment then I would either need to find a way to bump up the NOI to $12,000 a year or make my purchase price $83,333 based on that NOI of $10,000.
A cheap method that we use to determine value is to take the NOI x 10 and this gets you a ballpark value.
Then again, I have a 4 unit building that is nearly a 90% cap rate with an NOI of $10,000 a year. ($10,000 x 10 would be $100,000) but because it’s ugly, old, and in an unusual area, I would only get $50,000 from a buyer. It’s an ugly shoebox that still spits out money though.
This is how I look at commercial residential. This won’t get you the actual value but, it will tell you if you have a good ROI property or not.
Let me know if this helps.
Real estate works...
Hi,
I'm currently looking at a multi-unit residential property. Its vacant & needs total rehab. I was trying to run comps for it. But, it's impossible for commercial prop. I just have to get more understanding on figuring out the cap rate to insure its a good investment, before locking it up. My main concern is when I market it to buyers, I want to make certain my numbers are correct and I give them the proper info.
Ms. Monique
Charlotte, NC
~thoughts become things along with taking action~
{*when Life, Fear, Excuses get in the way- it's about showing up and doing it anyway!}
Thanks for sharing this great info. I had to save this.
Good luck in your investing
TC
Miami Florida
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