What’s it worth?

Valuing Commercial Real Estate

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New Hire Training 2021

 You’ll learn today

1. To answer, “What’s it worth?”

2. Review three methods to valuing

commercial real estate

3. Discuss which method to use &

when to use it

4. Introduce the concept of the “Broker

Opinion of Value”

5. Resources to keep learning

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 What’s
Commercial Real Estate?

• Unimproved land
• Buildings used for office,
industrial, commercial and
retail use
• Buildings leased to a 3rd party
• Buildings occupied by the
owner of the property

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 What’s What’s “Valuation of Commercial
Commercial Real Estate? Real Estate”?

• What’s the land or building’s

• Unimproved land
value?
• Buildings used for office,
• What is the land or building’s value
industrial, commercial and
to whom (owner, tenant, insurance
retail use
carrier, lender, etc.)?
• Buildings leased to a 3rd party
• Who is valuing the property and for
• Buildings occupied by the what purpose?
owner of the property
• Valued for sale? For financing? For
insuring? For litigation?

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Three approaches to valuation

1. 2. 3.

Reproduction or Comparable sales Capitalizing net

replacement costs approach operating income

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Reproduction or Replacement cost approach

• Usually highest due to new construction costs

• Used more for financing/insurance purposes than asset sales
• Most reliable for new properties with limited depreciation
• Marshall & Swift, RS Means Reports give industry cost breakdowns & values

Pros Cons
Up-to-date, timely, generic not always realistic, does not factor
numbers for property types depreciation, ignores market
economics

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 Comparable sales approach

• Compares “like assets” recently sold

• Reliable in active markets with adequate quantity and quality of comps
• Most relevant for owner-user properties
• Requires adjusting (up or down) price to reflect differences in comparables

Pros Cons
relevant, timely, explainable, Not always precise, too many variables, not
public numbers always “apples to apples”, use contingent
Uses public records for price, condition, s.f., etc.
Needs “fact checking” with brokers

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Capitalizing a property’s net operating
Income (NOI)

• Most widely used in asset sales Two best approaches:

1.
• Relies on property’s cash flow
Direct
Capitalization
• Requires knowledge of building’s rent
roll, net operating income (NOI)
2.
condition of the asset, capital markets
Discounted
and appropriate cap rates Cash Flow

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 Four methods to determine cap rates:

1 2 3 4

Market extraction rates Band of investment (Lender Published Market participant

(NOI/Sales Price) LTV (x) Loan Interest Rate + investor surveys interviews
Equity Return)

C C C C

(Project NOI ÷ Asset Value) 70% (x) 6.5% + 8% = PWC Capital Markets Brokers
$250,000 ÷ $4,166,066.67= 8.046% cap rate Corpaz Analytics Investors
6% cap rate JLL Research Developers

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 Factors used in determining cap rates
Age and property Real estate supply and demand factors
condition for local market and asset class

Tenant mix Interest rate activity at Fed and on

(Publicly traded? Privately held? Wall Street
Fortune 500? Size of tenants?)

Stability/credit Underlying economic fundamentals

worthiness of rent toll of the region (Rust Belt vs. Sun Belt)

Predictability of rental stream

(length of leases)

Demand for Lower Cap Rate = Higher Value

Asset Class Higher Cap Rate = Lower Value

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Valuation by direct capitalization method
The formula
Gross Gross potential rent (100% leased)
potential rent
Minus vacancy factor (5%-10% vacancy depending on
market/property type)

Adjusted gross Adjusted Gross Income (or Effective Gross Income)

income
Minus Operating expenses (utilities, janitorial, repair &
maintenance, insurance, etc.)

Property NOI before debt service and CapEx

Property NOI (/) by cap rate

Property Value Property Value

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 Income
Gross Income 1,000,000
Vacancy & Collection Loss 10%of GI 100,000
Example:
Capitalization Effective Gross Income 900,000

Method Operating Expenses

Operating Expenses $ 1.00 psf/yr 50,000
Reserve $ 50,000 per yr 50,000

Total Expenses & Reserve 100,000

Net Operating Income 800,000

Capital
Tenant Improvements 25,000
Leasing Commissions 25,000

Total Capital 50,000

Cash Flow 750,000

Property Value
7.50%Cap Rate 10,666,667

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What’s a “Broker Opinion of Value”?

Document assessing the value of a property

using 3 approaches:
1. Reproduction Costs
2. Comparable Sales
3. Capitalizing Income Stream

Usually prepared by a broker as opposed to an

appraiser

Not as comprehensive as a
complete appraisal!

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Components of BOV
1. Description of the property 5. Overview of economics and real estate
market

2. Summary of operating expenses and real

estate taxes 6. Overview of regional economics

3. Understanding of rent roll, NOI 7. Valuation based on reproduction,

comparables and NOI capitalization

4. Summary of potential capital, leasing and

marketing expenses

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Components of BOV
1. Description of the property 5. Overview of economics and real estate
market

2. Summary of operating expenses and real

estate taxes 6. Overview of regional economics

3. Understanding of rent roll, NOI 7. Valuation based on reproduction,

comparables and NOI capitalization

4. Summary of potential capital, leasing and

marketing expenses

Not typically found in BOV

• Detailed market description and analysis • Detailed operating expense history
• Specifics of rent roll – lease terms, rents, etc. • Actual proposals for capital repairs and
replacements
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How to use & why to use a BOV

Get Business
• Demonstrate market expertise
• Provide prospect savings vs. cost of an appraisal
• Use to get leasing or sales assignment
• Charge for the BOV (but credit against commission)

Transact Business
• Establish valuation for a client
• Recommended sales or purchase price

Keep Business
• Client retention tool – provide ongoing value
• Opportunity to provide high level analysis / deliverables
• Good “touch” when no transaction

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To summarize . . .

Three ways to determine value of commercial real estate

1. Reproduction or replacement costs | 2. Comparable sales | 3. Capitalizing NOI

Different approaches better suited for different situations

Multiple uses for valuation: financing, insurance, investment, sales

etc.
Approaches to valuation require knowledge of “Cap Rates and Cash Flows”

Broker Opinion of Value (BOV) not as comprehensive as appraisal - valuable to get, transact, and keep business

17
Broker KnowHow!

robert.manekin@am.jll.com
1 443 451 2613

© 2017 Jones Lang LaSalle IP, Inc. All rights reserved.