Every problem has at least two solutions: one that is simple and one that is complex. At times, the only accurate solution is the one that addresses a problem in all its complexity. At other times, the only answer we need is the one that puts us "in the ballpark." Then, the time and labor involved in calculation by the complex route are the price we pay for not having found the simple way.
The valuation of a multi tenant office can be lengthy, requiring the analysis of dozens of leases, each with its own rent rate and date of expiration. Computer programs (Pro Ject, Argus, and others) are available to enable appraisers to fully account for intricate lease patterns. Yet their intricacy can itself mask a basic simplicity.
One brief method for cash flow valuation is to use simple means to strip a building to what is essential to its value: the net income. Net income is what is left to the owner as the return for investment after all the expenses (except the mortgage) have been paid. We think of an office building in terms of so much rent per square foot per year. Each building typically has its own predominant rent rate. This is a $14.00 building, that one $22.00. Start with that. Then, deduct an overall market allowance for vacancy, and you have "effective gross."
Leases in modern offices are written with expense stops. Real estate taxes and other expenses are "stopped" for the landlord at the then current rate in a lease's initial year, with the tenant reimbursing the landlord for increases in succeeding years. Deduct the stop. All that is left then is to take a small allowance for brokerage and a replacement reserve, and you have the net income. Capitalize that at a rate that for many average buildings is 11% (to capitalize at 11% is roughly to multiply by 9), and you are in that building's value ballpark.
For a typical suburban building with $17.00 per foot rent, 15% vacancy, a $6.00 stop, reserves and brokerage of $1.00, and a "cap rate" of 11%, the ballpark is about $68.00.
Appraisal Data Source tracks average prices for the large body of data in commercial property sales. Not so coincidentally, ADS reports, $70.00 per foot ($70.18, to be exact) is roughly the current average price for offices in Greater Boston. The income from the average building produces the average price. We want to be careful, of course, to only apply average data to average buildings. Some buildings are not average: the Bay Colony complex in Waltham, selling at $184 per square foot, and the Wang Towers in Lowell for 35 cents. These are exceptions, and, because they are, they command our attention. The analyst needs an awareness of these. But they don't invalidate what for average buildings is a rule. And that is a second simple method of analysis: to be "anchored" at average numbers and to only come far off these when a building shows us something out of the ordinary.
Simple methods are only a bare bones substitute for analyses that fully account for a building's complexity. But they do help us to see the forest as more than a confusion of trees. To the extent that they keep us rooted in basics, they help form the firm ground for valuations that appraisers produce by more complex means.
Eric T. Reenstierna, MAI
The Reenstierna Associates Report is published as a service to the clients of Eric Reenstierna Associates and other real estate professionals. The views expressed are those of the articles' authors and do not necessarily reflect those of other members of the organization. Copyright 1996. All rights reserved.
Eric Reenstierna Associates