Confused about Sellers using NOI to value partially vacant buildings

[David Switzer]

Hey all,

I seem to keep running into this issue so thought I'd seek advice.

Using NOI formula to value a building, you have Value, NOI, and cap rate. To me, this means if your NOI is 100k and the cap rate is 10%, the building is valued at $1mm.

However, when looking at partially vacant both commercial condos and mixed use (the commercial unit being the one vacant), sellers near me seem to be using the Commercial unit's Pro Forma income to fill in the formula.  I have been told this is more common in full residential buildings where it is much easier to rent out the units (bigger tenant pool, shorter leases), but I am seeing it consistently in commercial.

Example 1: A vacant commercial condo near me is asking $1.2mm, based on a "future" rent of $6000 NNN. The space is nicely built, but is also an odd configuration which would rule out many tenants. I asked the seller why I should pay the full NOI calculation value for a space where finding the tenant is the biggest job, and he refused to come down even $1.

Example 2:  A mixed use building has 3 units, 2 residential at around 1500 SF and a commercial of 5000.  The residentials are rented out at $3k a year, but the commercial unit, also a very "unique" space which rules out many tenants, is vacant.  In their asking price they used $10,500 in commercial rent to fill in the NOI valuation.

I understand it is fully unreasonable to use $0 for the commercial units rents even though they are currently vacant, but shouldn't there be a discount factor based on how difficult it would be to fill the space?  Especially if the commercial is 50+% of the building.


Thanks!

- David

[Russell Brazil]

If the building is vacant, is it's value zero? No of course not.

Is it worth more if it was 100% tenanted, yeah. 

So whats the value? A slight discount if its a generally an easy to fill commercial space. If there is something hard to fill, well then plays into a larger discount.