How to determine value of a commercial property without appraisal

Question

I just found out about a commercial property in my area that is for sale by owner. (Family friend is selling).  The building is prime property in our town.  The building has the potential for 4-5 tenants- hair stylists, massage therapists, artists or office space.  The owner is saying up front that she's asking $395k for the building.  This seems like wishful thinking to me as the current rent she's collecting is only $1650 (she is a current tenant as well so there is room for growth), insurance and taxes equal $516 per month and utilities are on average $300 per month.  How can I calculate value with only this information? And how can I make a sensible offer based on this information? Thanks in advance!

Ronald Rohde · Answer

Offer $250 with a financing contingency, lender's appraisal may surprise both of you (i.e. lower)

if they appraise at $200k and lend 75% would you come up with extra cash to close?

Adam Johnson · Answer

Glad to help. As the buyer, you determine the value to you after factoring in everything. I have walked away from deals I really wanted to happen because the sellers desires and my desires just didn't match. I NEVER buy based on an appraisers opinion, I rely on my own opinion after digging into the deal.

Jenny Gremillion · Answer

@Adam Johnson thanks so much for the detailed response! You're correct, this is a smaller boutique building in a historic downtown area. No box stores in this area.  Based on the numbers I have right now from the owner, the most I could pay for this building, to make sense to me is $260K.  There will be financing involved so I would have to add debt service to my numbers.  Me and my husband both could use the space for other businesses we have (office space) so there's that value (husband is renting somewhere else now) but all things considered, without getting an appraisal done, I believe $395k is way over priced.  Thanks again!

Adam Johnson · Answer

It kind of depends on what your end game is.  Part of the consideration is the "highest and best use" for the property.  If that is the current configuration, then dig deeper.  If it is better to be bulldozed and build a big box store on it, then it is a whole different analysis.  Ultimately, in any investment, a property is worth what a buyer will pay for it.

A real quick summary here.  Determine how many leaseable spaces exist.  Then determine what the total potential rent that could be collected for those spaces.  That is your maximum potential income.

Next, add up all of your costs - utilities, taxes, management fee (even if you manage it yourself, this has value), maintenance including reserves for big ticket items, any landlord utilities, any landlord common area maintenance, and an allowance for vacancy based on what is typical in your area.

Subtract expenses from potential income, that equals your net income.  Ask around your current area to get an idea what CAP rate similar properties sell for in your area.  It is important to use similar properties, you won't want to compare the subject property with a big box national brand retail property with an A-credit tenant on a 20-year lease, for example, because it doesn't sound to me like that is the type of tenant your subject will appeal to.  Once you know have a reasonable CAP rate, you can figure an approximate value based on the income approach, which is likely what an appraiser would use for this type of property (though this is not ALWAYS the case).

Using your numbers above (which don't include all expenses or income, just a demonstration) and taking a wild guess of a 13 cap rate (don't use that number without verifying it), the net income would be $ 834/month x 12 = $ 10,008.  Take 10,008 divided by .13 and you end up with $ 76,985 in value using the income approach.  Again, my example numbers miss a lot, so don't use them.

You make your money when you buy.  When I buy, I look closely at CURRENT income.  If a property is 50% occupied, I base my decision largely on that.  It is going to be MY time/effort/cost to increase occupancy, so I should reap the rewards more than the seller that doesn't want to deal with it.  Be sure to look at occupancy in other nearby properties.  Is it just this property that is stressed or are others stressed.

One last thought - CAP rate calculation does NOT take into consideration debt service.  You should also look at the potential cash flow on the property.  Let's say you are able to buy the property at a 13 cap (or whatever cap for that matter) based on current occupancy, that may look like a good deal.  But if the occupancy is only 25%, you may find that minimum expenses and debt service coverage are more than the total income, so you just bought yourself a potential money pit.  Maybe it's still worth it, but you need to know that before you commit to anything.