Welcome to the official blog of Block Real Estate Services, LLC (BRES). BRES seeks to offer insight and news concerning commercial real estate, financial investments, construction and development of the 212 communities we serve locally and nationally.

Monday, August 10, 2015

Valuation of Commercial Real Estate: Part 3

Valuation of Commercial Real Estate: Part 3There are various ways for income capitalization: gross rent multiplier, capitalization rate, cash-on-cash return and discounted cash flows.

Gross Rent Multiplier
  • Price divided by Gross Income
  • Least used method – more common with MF
  • Advantages
    • Very little info required, easy to obtain
    • Use for quick comparisons of similar properties
  • Disadvantages
    • Does not take into account many important factors, including appreciation, operating expenses, leverage, taxes or risk level
Capitalization Rate
  • NOI/Purchase Price = Cap Rate
  • NOI/Cap Rate = Purchase Price
  • Advantages
    • Takes into account income/expenses
    • Most commonly used method
    • Easy comparison
  • Disadvantages
    • Does not factor appreciation, leverage, taxes, risk
    • Only considers 1st year projected income
    • Not appropriate in many situations (near-term rollover, heavy capital requirements, low occupancy, value-add situations)
 Cash-on-Cash Return
  • COC = cash flow after debt but before taxes initial equity investment
  • If paying cash, COC = Cap Rate
  • Good way to determine “yield” in early years
  • Most comparable to dividend yield rate on a stock or the coupon rate on a bond
  • Advantages
    • Takes into account capital costs and debt structure
    • Easy to understand for cash oriented buyers
  • Disadvantages
    • Does not account for appreciation/depreciation, taxes or risk level
    • Hard to get meaningful comparison among potential investments
Discounted Cash Flows
  • Use forecasting model of expected cash flows
  • Can determine IRR, NPV and capital accumulation
  • Advantages
    • Takes into account all facets of an investment, including cash flow, capital repairs, debt and sale
    • Recognized as best method for valuation
    • Use of Argus Software and other models helps
  • Disadvantages
    • Can be difficult to get all info – relying on estimates
    • Heavily “back-end” weighted due to impact of exit assumptions
Net Present Value (NPV)
  • Sum of the present value of all future cash flows minus the initial investment
  • Advantages
    • Allow investors to set return benchmarks and price accordingly
    • Good for comparing alternatives
  • Disadvantages
    • No compensation for size/time disparities
    • No consideration of how intermediate cash flows can be reinvested
    • Positive and negative cash flows discounted at same rate
Internal Rate of Return (IRR)
  • Percentage rate earned on each dollar invested for each period its invested
  • IRR is the rate at which NPV = $0
  • Advantages
    • Good method for comparing alternatives
    • Answers basic questions about expected timing and amount of +/- cash flows
  • Disadvantages
    • No compensation for size/time disparities
    • No consideration of how intermediate cash flows can be reinvested
Click here to see the entire Valuation of Commercial Real Estate.


Aaron Mesmer - Block Real Estate Services, LLC (BRES) 
Aaron Mesmer
Acquisition & Sales

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