8-4 Valuing Commercial Real Estate BuildingOne Properties is a limited partnership
formed with the express purpose of investing in commercial real estate. The firm
is currently considering the acquisition of an office building that we refer to simply as
building B. Building B is very similar to building A, which recently sold for $36,960,000.
BuildingOne has gathered general information about the two buildings, including valuation
information for building A:
Per Square Foot Total Square Footage
A B A B
Building size (sq. ft.) 80,000 90,000
Rent $100/sq. ft. $120/sq. ft. $8,000,000 $10,800,000
Maintenance (fixed cost) (23)/sq. ft. (30)/sq. ft. (1,840,000) (2,700,000)
Net operating income $ 77/sq. ft. $ 90/sq. ft. $6,160,000 $ 8,100,000
Buildings A and B are similar in size (80,000 and 90,000 square feet, respectively).
However, the two buildings differ both in maintenance costs ($23 and $30 per square
foot) and rental rates ($100 versus $120 per square foot). At this point, we do not know
why these differences exist. Nonetheless, the differences are real and should somehow
be accounted for in the analysis of the value of building B using data based on the sale
of building A. Building A sold for $462 per square foot, or $36,960,000. This reflects a
sales multiple of six times the building’s net operating income (NOI) of $6,160,000 per
year and a capitalization rate of 16.67%
Using the multiple of operating income, determine what value BuildingOne should
place on building B.
b. If the risk-free rate of interest is 5.5% and the building maintenance costs are
known with a high degree of certainty, what value should BuildingOne place on
building B’s maintenance costs? How much value should BuildingOne place on
building B’s revenues and, consequently, on the firm?