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Valuing Commercial Assets Requires Looking Beyond Cap Rates

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Regardless of market conditions, now is always a good time to get a clear picture of your asset’s worth


When it comes to figuring out a commercial property’s value, there’s a common habit among owners, stakeholders and clients to get overly focused or hung up on an asset’s cap rate.

While an important element of the overall basket of metrics used to evaluate and appraise a property, a cap rate is only part of the puzzle — and one that involves many variables such as in-place rents, remaining lease term, tenant covenant, and physical condition.

A better way to determine the value of your warehouse, office building, shopping centre or apartment building should begin with a broader question: What is the market? That means assessing and calculating a variety of indicators including the current rent and market rent range, in addition to analyzing interest rates and capital costs.

Prioritizing answering these questions is going to have a far greater impact on determining the value of your asset while also giving you deeper insight into other utility, like how much you can borrow against the property, or how much you can invest in it — and how it can be leveraged as a component of your overall portfolio.

What exactly is the cap rate?
A property’s going-in capitalization rate, or cap rate, is net operating income of the asset, divided by the price. The net operating income (NOI) is defined as rents minus expenses. If you paid $1,000,000 for a warehouse and you generated an NOI of $50,000 in any given year, you would have a cap rate of 5% for that year. However, if you believed that market rents are higher than the in-place rents, one would determine that the stabilized cap rate is higher than the going-in cap rate. This is an important distinction to make when discussing cap rates.

Another way of looking at cap rates though is to think of it as a measure of risk. Many people think that cap rates are based off interest rates, but that’s not entirely the case; cap rates have a closer relationship with bond yields.

If we look at a typical industrial building lease of a five-year term, then we can compare the yield of that lease to the five-year bond market. If I’m holding real estate, I want to make sure it carries a more profitable trajectory than investing in the bond market or other low risk investments.

With real estate, there are certain risks to assess such as changing interest rates, depreciation, tenant stability, vacancy, rising taxes, opportunity costs, and so on. These are all considerations when it comes to accurately valuing your property.

Today, we’re generally seeing cap rates escalate across the various asset classes due to increasing bond yields and overall market volatility driven by global issues such as high inflation, war, and weakening consumer demand.

Painting the whole picture
It’s important to work with valuation and appraisal experts to get a full picture of the value of your asset.

In addition to having a firm grip on your relevant cap rate and current market trends, owners should also seek to understand what the future may hold. That means running actual cash flow models on your assets to try to predict where rents and revenue are trending.

That information can help inform or guide a development pipeline when coupled with vacancy forecasts and other macroeconomic indicators.

When trying to land on the value of your asset, it’s essential to have a handle on what the market rent is and where those rates are headed in the short term and the long term.

Why now is a good time to get your asset valued 
These days, appraisers and advisors must do their work amid economic headwinds, market volatility, and questions over the stability of global banks. Uncertainty aside, it’s always wise to have a firm understanding of the value of your property.

Now is always a good time to run the calculations, but it’s also important to have a service partner who understands the interplay between all the key factors and who can apply national expertise to regional or local trends.

A property’s cap rate, costs, cash flow, market rents, and taxes are intertwined. So rather than throwing darts at a board to figure out your value based on limited information, it makes sense to have an expert appraisal that provides owners with a level of certainty backed by real life comparable data.

Furthermore, many appraisals completed within the last year or two are no longer relevant. The market has evolved too quickly. If an owner needs to refinance their building, or if you’re looking to renovate, sell or buy, a holistic valuation is going to give you a better perspective on what action you should take and what kind of returns you should be targeting. In most cases, a financial institution is going to require an appraisal for any kind of refinancing or new financing.

In markets like this, we still see many property users and owners expanding, relocating or adjusting their businesses. Not everyone is a large, institutional investor who has the luxury of sitting on the sidelines, content, waiting for markets to calm and normalize. For many, business must continue.

So, for those who must take action, it’s essential that they rely on an accredited, professional valuation that goes beyond cap rates and dives deeper into a diverse set of value indicators and market signals. 
 

For More Information, Please Contact:

Adam Grisack

Senior Director

Calgary

Adam graduated from the University of Victoria in 2010 where he earned his B.A in Economics, and a business communications minor. Since joining Colliers, Adam has worked primarily in appraisal of industrial, mixed-use, multi-residential, and retail properties. In addition to the foregoing real estate assets, Adam has experience in the valuation of aircraft hangars, automotive dealerships, hotels, cannabis facilities, motorsports facilities and redevelopment lands. 

Adam has developed strong relationships with local developers, brokers, owner-users, and investors. He has worked with a wide range of clients across all asset classes.  

He has a passion for great service, and strives to anticipate client needs while providing expert advice. Outside of the office Adam enjoys skiing, kickboxing, spending time with friends, and playing music.

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