Let take a closer look at a hypothetical building in 2007. The major factors affecting the value of this building: rental rates, vacancies and capitalization rates were average for the market. Based on it's operating income of $70,000 it was valued at $1,000,000 as shown below:
Rental rate 100% of the market rate
Vacancy rate 7%
Operating Income $70,000
Cap Rate 7%
Cap Value $1,000,000
Since 2007, all factors affecting value have weakened.
Rents are down over 20% (and going lower).
Vacancies are up nearly 13% (and going higher). Capitalization rates are probably 300 bps higher (and as the meltdown continues, headed higher). Today our hypothetical building has probably lost over 50% of its value:
Rental rates 80%
Vacancy rate 20%
Operating Income $44,800
Cap rate 10%
Cap value $448,000
Ouch! A 50% haircut. So, how do you beat the math in this trilema? Find an owner/occupant participant who can take on 50% of the available space, and, a building facing a 50% vacancy rate. Show a potential owner/occupant rental rates 20% lower than 2007 with an equity kicker and you probably have a partner.
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