Commercial Property Cap Rate? Good Deal or Bad?

Question

Im looking at a 24k sqft flex building that I currently rent from.  It's a pretty awesome building 2 miles from downtown.  Easy access to and from.  Parking lot, garage doors, clean etc.

It's rent potential is $11.7k.  it's about 1/2 rented and my business could take that empty half honestly.  That's apart of the intrigue.

They want $1.4M for it.  I got approved for an SBA at 10% down.

The cap rate seems to be 2.7% if I'm doing my math properly but I'm not sure.

Can anyone give me guidance or advice on what to look for or ask to the sellers etc?

This is my first commercial deal.

Thank you so much!

Ronald Rohde · Answer

I don't think your math is correct. Even rent controlled apartments in LA trade at a 3+ cap rate.

Base your offer price on actual revenue, not potential.

Immanuel Sibero · Answer

@Josh Delaney

I'm in the process of learning commercial real estate investment as well... this BP forum has been very helpful. I think this is a good example of why simply looking and calculating the "cap rate" really does not tell you much and doesn't get you very far. So you take the NOI and then divide by the asking price and you get 2.7% and then what?

What you need is the market cap rate - it's the blended (average, if you will) cap rate at which buildings that are comparable to your building have been recently transacted (i.e. changed hands) in the local market. You can get this rate from knowledgeable local investors, commercial brokers, local bankers, etc. You can then apply this market cap rate to the NOI of your building in question to estimate the value of the building. The fact that the building is half empty is further complication for you because you need to find out why it's half empty. Not enough demand (i.e. fierce competition)? Mismanagement? Declining market? Outdated building? Another complication is current leases for example if the building is locked into a long term leases at a rate that's lower or higher than market then it could be a discount or a premium to the building valuation.

The above would just get you an estimated value of the building. It still won't tell you if it's a good or bad deal. You would have to do further analysis into the future using metrics such as CoC, IRR to determine if it's a good or bad deal. For example, you may have requirements of at least 10% CoC and 18% IRR. In this case the building needs to exceed those requirements in order to be a good deal.

Cheers... Immanuel

Nathan Gesner · Answer

That seems like a low cap rate but it's half empty.

READ THIS for a thorough explanation of cap rates with examples and what a buyer should look for.

Greg Dickerson · Answer

You first have to determine the net operating income for the property.  You take the gross income annually minus all of your expenses taxes insurance maintenance utilities etc. to derive at the net operating income.

Once you have determined and NOI you divide that by the asking price to get your cap rate.