How to compare area Cap rate when determining Commercial Building Value

Question

I bought a building on seller financing last year due to the low rents that the units were paying and received a fair purchase price for the property.  I'm wondering how to estimate the value of the building-based NOI/Capitalization rate.  NOI is $50,220 but I can't seem to figure out the Cap rate on a 6 unit building.  It's a mix of 2 residentials and 4 commercial rents.  Any help would be greatly appreciated!

Henry Clark · Answer

OP.  Your responses raise a lot of questions to me.   You need to engage with an experienced commercial investor or a commercial agent or broker.

Ask them to go through your entire operations.

Based on your info your at a 9,7 cap rate.  You did not answer on your capex.

You need someone local to deep dive on your operation.  Otherwise there are a lot of questions, which a post is not a good medium.

Jason DiDonato · Answer

I agree!  Thanks, I appreciate the information!

Evan Polaski · Answer

@Jason DiDonato

I would call a few real estate agents, preferably those that focus on commercial properties in your area, to give you a stabilized ARV.  While I think you know this, these are clearly just estimates based on each persons general opinions, given today's market conditions.

Hop on LoopNet, find a few agents that are listing properties in the area, and give them a call.  I would expect to pay for their services, but it will at least get you a decent idea, and I would imagine a BOP won't cost you much.

Jason DiDonato · Answer

The numbers when I do that are significantly skewed because the rents were so low.  Purchase price was $600K.  Rental income was $3,505 ($42,060 annual).  Expenses when purchased $16,518 ($6,360 annual 10% capx), NOI of $25,542.  Cap Rate was 4.3%.

Current rents are now $80,400, Expenses are $21,540 (10% capx included), NOI of $58,860.  If I did the same 4.3% cap rate the value would be $1.3 mill which is not an accurate value for the property, unless I'm missing something!

Looking to understand value as we will need to potentially refinance in 1-2 years because its seller financed and has a larger rate increase and ballon clause in the near future.

Nick Maugeri · Answer

I don't know all of the details, but high level estimates:

Acquisition:

GOI: $42,060

EGOI: Less 2.5% vacancy, $41,430

Taxes, R&M, Capex, Insurance, PM: Less 40% (est.)

NOI: $24,860

CAP: 4.3%

Existing:

GOI: $80,400

EGOI: $79,195

NOI: $47,516

CAP at 4.3%: $1.1M

The CAP in your market it not 4.3%, likely closer to 8%: Value then is ± $595K. You can confirm this based on (1) comparable sales and (2) contacting local CRE Brokers to determine market CAP for asset type. You don't use the same CAP rate, just because you purchased at a 4.3 CAP does not mean that the CAP is 4.3%.

Henry Clark · Answer

OP.  You are not going to find a Market cap rate that is comparable to the property you own.

2 residential, 4 commercial, These types of contracts, these type of contract durations, these types of lessors, this type of building, that type of location, that type of road access, that type of parking, etc etc. Not going to happen in your market.

The true value of your property is its Cashflow after taxes to you.  Amortized at your market interest rate.  Less CAPEX needs.  A.  To start with take what you paid, less Capex in the next 5 years.  That is one value figure., B.  Take your cash flow at your market interest rate, less Capex in the next 5 years.

Why do you want the value????  You just bought it.

You want the value based on what you will get the rents up to.  Just put the projected rates into your NOI or cashflow projections.  Take the Cap rate you paid originally.  Divide your New projected NOI by your prior Cap rate.  Again, I would reduce it by any Capex needed in the next 5 years.

Jason DiDonato · Answer

I was looking more towards the market cap rate.  Trying to get a better understanding of what the true value of the property may be.  We have a change in the interest rate for year 4 and 5 before final balloon payment is due and I was just looking to see what value might be based on what we have and will be getting the rents up too.  Appreciate everyone's help!

Nick Maugeri · Answer

Contact a local CRE Broker and ask them what the market CAP rate is for your asset type (MU/FLEX). You should want one on your team anyway. If you need recommendations, referrals, etc., send a DM and I'll share a few professionals who do the most volume in your market.

Nick Maugeri · Answer

CAP is not estimated. You just need to run comps to determine CAP for a given market. Looks like you should be around 8%. To determine your CAP, divide $50,220 by the purchase price. If your asset can be valued at an 8 CAP, current value is $627,750.

Evan Polaski · Answer

@Jason DiDonato, are you trying to figure out your cap rate or a market cap rate?

As noted, you paid a price for the property (value).  You have an in-place NOI.  NOI/Value=Cap Rate.

If you are looking for a market cap rate, that can be trickier to determine without many market transactions available, and even then you likely don't know the true NOI unless you saw the seller's financials.

Why are you wanting the cap rate now?  If you already own the property, it is done.  And the market cap rate changes.  In 2021, cap rates were super low because financing rates were low and there was a ton of demand for all sorts of real estate.  Today, cap rates are much higher because of fears of recession, uncertainty with just about every aspect of life, and interest rates being higher the recent memory.

I would argue that cap rate, in most real world transactions, is one step short of meaningless.

How to compare area Cap rate when determining Commercial Building Value

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