Confused about Sellers using NOI to value partially vacant buildings

Jersey City, New Jersey
Commercial Real Estate Investing
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Confused about Sellers using NOI to value partially vacant buildings

David Switzer
Member since 2024 · 35 posts · 20 votes

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

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Russell BrazilBusiness Member
Moderator
Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
8mo

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.  

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  • Russell BrazilBusiness Member
    Moderator
    Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
    8mo

    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.  

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  • John M.
    Investor · Fairfax, VA · Member since 2015 · 1k+ posts · 798 votes
    8mo

    Unfortunately this is common, but it's also a red flag. It also means that the current seller wasn't able to lease it. Ask the seller when was the last time it was leased and do they have a copy of that lease. Also banks are only going to finance the property based on actual tenants paying rent. Old configurations, size of the space, HOA rules, ceiling height, steps, and parking are all considerations when evaluating these kind of spaces. Also take note of the foot traffic. Usually one side of the street will have more traffic than the other.

    Answer:  Yes you need a discount!

    2Reply
    • David Switzer
      OP
      Member since 2024 · 35 posts · 20 votes
      8mo
      Quote from @John M.:

      Unfortunately this is common, but it's also a red flag. It also means that the current seller wasn't able to lease it. Ask the seller when was the last time it was leased and do they have a copy of that lease. Also banks are only going to finance the property based on actual tenants paying rent. Old configurations, size of the space, HOA rules, ceiling height, steps, and parking are all considerations when evaluating these kind of spaces. Also take note of the foot traffic. Usually one side of the street will have more traffic than the other.

      Answer:  Yes you need a discount!

      Yeah so my specialty is buying empty commercial units and putting in a tenant, and in this scenario I already have a tenant ready to sign a lease.  So I'm all good there, but I definitely don't want to compensate the owner for my work getting the tenant lol
      2Reply
  • Rick Pozos
    Wholesaler, Rehabber and Landlord · San Antonio, TX · Member since 2014 · 2k+ posts · 2k+ votes
    8mo

    Agree with the above. I should get paid for turning a 50% occupancy into a 100% occupancy. I hate to see commercial properties that say 7cap, but then they say 45% occ. If it was truly 7cap, it would be on the rents that are actually being collected. BUT that is usually how they do it on the commercial side.

    2Reply
  • Henry ClarkPro Member
    Developer · Member since 2020 · 4k+ posts · 4k+ votes
    8mo

    OP based on your background, you already know the answer to your question.  To move the discussion further, it is more about the seller having the Market teach them market value.  

    A.  How old is the listing?

    B.  How long has that part of the lease been vacant?

    C.  How special is that location? parking, turn in, street traffic, etc.

    D. What Capex is needed?

    E. Did you develop your own NOI or use theirs?

    F.  Neighbor businesses are they complementary?

    G.  Has the property had a stepped up basis recently?  Are the new owners wanting out?

    To me the above is what move the discussion further with yourself from the buyer's side and from the seller's side.  There is no point trying to educate a Seller on the Markets true value, if they just listed.

    1Reply
  • Chris SeveneyBusiness Member
    Moderator
    Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
    8mo

    Cap rate is a tool for for an initial evaluation. But a hardened pro forma should be done to determine future cash flow flows and absorption rates to fill those units to come up with a discounted amount. As you know, it is not worth full value as occupied, but it is also not worth zero. It will be somewhere near their number not zero but how far you can get it down truly depends on how desperate they are to sell it

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  • John M.
    Investor · Fairfax, VA · Member since 2015 · 1k+ posts · 798 votes
    8mo

    I bought an empty condo 1.5 years ago for $490K.  Market value with tenant is about $700K. It took me 9 months to collect rent it and my carrying costs were about 48K.  Every deal is different but wanted to share my experience.

    1Reply
  • David Switzer
    OP
    Member since 2024 · 35 posts · 20 votes
    8mo

    I'll give some basic on the deal:

    7000 SF building, 3 floors, 2 apartments above 1 commercial.

    They are 3-bed 1 bath apartments, paying $3000/month. (leased)

    The Commercial is approx. 5000 SF, but is an irregular configuration.  It was an auto mechanic so has the metal drop down gate leading into a small covered space that fits say 2 cars, which leads into an outdoor area of maybe 500 SF, and then into a large almost warehouse type building that is prob 3500 SF.  It also has 2 small offices.

    I would never buy this building without a tenant in mind, and luckily for me I have the perfect tenant who has already agreed they want to lease it.

    The asking price is about $2mm, and they based this on $200k of NOI and a 10% cap rate. They for some reason did not include about $30k in building expenses. This is also based on a $10,600 assumption they made about the commercial space rent. They currently also have the space for rent and the broker is looking for 8-10k.

    I believe I could get $10k a month or so from the new tenant.

    To me, the building is worth 2 Apartments (6k/month), the commercial potential rent they assume (8-10k, lets say 9k), minus the building expenses.

    $180k gross rent - 30k in building expenses, = $150k.  150k - 10% (their listed cap rate) is $1.5mm.

    They bought the building 1.5 years ago for $899k, but it has been recently been fully renovated and I am certainly willing to pay more than $1.5mm, but I would think more like $1.75 is fair.

    Thoughts?

    0Reply
    • Russell BrazilBusiness Member
      Moderator
      Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
      8mo
      Quote from @David Switzer:

      I'll give some basic on the deal:

      7000 SF building, 3 floors, 2 apartments above 1 commercial.

      They are 3-bed 1 bath apartments, paying $3000/month. (leased)

      The Commercial is approx. 5000 SF, but is an irregular configuration.  It was an auto mechanic so has the metal drop down gate leading into a small covered space that fits say 2 cars, which leads into an outdoor area of maybe 500 SF, and then into a large almost warehouse type building that is prob 3500 SF.  It also has 2 small offices.

      I would never buy this building without a tenant in mind, and luckily for me I have the perfect tenant who has already agreed they want to lease it.

      The asking price is about $2mm, and they based this on $200k of NOI and a 10% cap rate. They for some reason did not include about $30k in building expenses. This is also based on a $10,600 assumption they made about the commercial space rent. They currently also have the space for rent and the broker is looking for 8-10k.

      I believe I could get $10k a month or so from the new tenant.

      To me, the building is worth 2 Apartments (6k/month), the commercial potential rent they assume (8-10k, lets say 9k), minus the building expenses.

      $180k gross rent - 30k in building expenses, = $150k.  150k - 10% (their listed cap rate) is $1.5mm.

      They bought the building 1.5 years ago for $899k, but it has been recently been fully renovated and I am certainly willing to pay more than $1.5mm, but I would think more like $1.75 is fair.

      Thoughts?


       What's the prevailing cap rate on mixed used properties of the same class in the area?

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  • Ronald RohdePro Member
    Attorney · Dallas, TX · Member since 2016 · 5k+ posts · 2k+ votes
    8mo

    make the offer at the price you'd pay, then move on. Lots and lots of sellers aren't really motivated

    1Reply
  • John M.
    Investor · Fairfax, VA · Member since 2015 · 1k+ posts · 798 votes
    8mo

    Why would you offer more than 1.5 if you think that is what it's worth. Make the offer and move on. See if you can get the new tenant to cover a portion of those building expenses (NNN) as well. Ask the seller for seller financing to help you save money as well when negotiating.

    1Reply
  • J CastroBusiness Member
    Lender · Florida · Member since 2025 · 673 posts · 240 votes
    8mo

    Hey @David Switzer, good post — you’re not wrong, and your instincts are solid.

    What you're running into isn't a misunderstanding of the NOI formula, it's a pricing disconnect between sellers and reality, especially in commercial and mixed-use.

    A few key points to unpack:

    1. NOI vs. Pro Forma NOI
    You’re absolutely right that value = NOI / cap rate. The issue is which NOI is being used.

    • In-place NOI = what the property is actually producing today

    • Pro forma NOI = what the seller hopes it will produce after lease-up

    Sellers almost always want to price off pro forma NOI. Buyers should underwrite off in-place NOI, then decide how much risk they’re willing to take to reach pro forma.

    2. Vacancy risk is not free
    Using pro forma rent on a vacant commercial unit assumes:

    • Zero lease-up time

    • Zero TI costs

    • Zero free rent

    • Zero broker commissions

    • A tenant who wants that specific space

    That’s rarely realistic, especially for:

    • Odd layouts

    • Large commercial footprints

    • Specialized or “unique” spaces

    In commercial, vacancy risk is real money, not theoretical.

    3. Why sellers refuse to discount
    In many cases:

    • They don’t need to sell

    • They’re anchoring to a future story, not today’s cash flow

    • They’re hoping for a buyer who underwrites optimistically or needs to place capital

    That doesn’t make the pricing correct — it just means they’re fishing.

    4. How this is normally handled by experienced buyers
    Seasoned buyers will:

    • Value the property on current NOI

    • Add a lease-up reserve (TI, commissions, downtime)

    • Discount price or require seller credits

    • Sometimes structure earn-outs or delayed consideration

    If commercial is 50%+ of the building and vacant, most rational underwriting will reflect that risk.

    5. Residential ≠ Commercial
    You’re correct that residential vacancy is treated differently because:

    • Larger tenant pool

    • Shorter lease terms

    • Lower TI costs

    Commercial space—especially unique space—does not deserve the same assumption.

    You’re not “missing” anything. Sellers are pricing based on hope and pro forma, while you’re underwriting based on risk and reality.

    The market eventually resolves this:

    • Either the space leases and justifies the price

    • Or the seller sits… or cuts

    Your job as a buyer is to stay disciplined. Overpaying for hypothetical NOI is how deals quietly go bad.

    Good post — this is a real issue more buyers should be questioning.

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  • Bob Dole
    Member since 2024 · 65 posts · 25 votes
    8mo

    I've seen these pro-forma cap rates as well.  My question is this, are these types of listing due to the sellers or the listing agent?

    Seems like a lot of wishful thinking by the seller/agent....

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