How would you value a single tenant office building with the tenant being AAA rating versus BB rating?
Hey guys, I am trying to value a single tenant office building but the tricky part is the value would be very much different if a AAA rating tenant comes in versus a BB rating tenant comes in. So I need to present two scenarios. What would be a reasonable way to value it in real world?
Now I have three thoughts:
1. Cap two scenarios in different rate. The questions is how to determine the gap between the two cap rate?
2. Apply a higher general vacancy rate for BB rating tenant. The question is how high can it be?
3. Use DCF to get the property's value first and then apply a discount rate for BB rating tenant? But again, how to determine what the discount rate is.
This is my first time dealing with this problems so any thoughts/comments is welcomed. Thank you!
It would depend on how the potential leases are structured. Whether or not the AAA tenants have a way out of their lease. Typically owning a AAA lease is like owning a AAA bond. The cap rate should mirror the going interest rates on the corresponding bonds. Traditionally, vacancy is underwritten to 3% in single tenant scenarios (unless tenant is complete junk) and to 0% if the tenant is credit.
Thanks for your comments. I totally agreed with you. The ownership think they can get a AAA tenant thus they are asking an unreasonable price. I am trying to show a trading range if they end up get a non-AAA tenant and BB would be the worst case scenario. As far as I know, it would be a 15-year lease but not sure if the tenant can go other places until we know who is coming in.
Single-tenant NNN deals often trade like bonds... You really only have to attribute a risk premium to the going-in yield. There is no secret formula that tells you exactly what that is, but you could always look to the debt markets to try and gauge how others value differences in credit.
Thanks for the helpful suggestion!
Bear in mind yes def look at as a credit rating spread to a bond of the debtor but not a lease is an UNSECURED loan in the eyes of the lessor whereas a normal creditor would be secured by collateral this of course assuming the lease is non-recourse to any parent entity. Thus if you goto the debt markets and get a bond spread of the AAA tenant you would have to adjust that for the risk of it being unsecured no different than any unsecured non-recourse loan to the lessee.
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