How you guys underwrite vacant cre deals
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Cap rate is less relevant for vacant or otherwise non-stabilized properties, your better options are:
1) DCF using lease up assumptions over time, solving to a higher IRR to reflect extra risk of lease up
2) Comps. Have other similar vacant deals sold? (and what was their price PSF/per unit/etc?) This is easier if the property is vacant b/c its a new development. If its vacant b/c its distressed you'll likely have to factor in more adjustments vs comps.
3) If its vacant because its a new development, you could also back out the prior owners acquisition/construction costs + a reasonable profit margin for them to come up with a rough approximation of where pricing should be.
Thanks alot for this great insight.
The latter - you need to know what you can feasibly rent the property for given market conditions, what it'll cost you to lease it up and any interim holding costs, then work from there.
I'm not even sure how you'd assess a vacant property based on a desired benchmark cap rate - if it has no income, I can't value it on a cap rate basis without knowing what kind of rents it could achieve.
A property owner with vacant building cannot expect the the property to sell for market correct? Buildings are valued based on income so if there isn’t any, the next buyer needs to account for lease up risk?
Correct, it would sell at a discount to market.
Only exception would be if the buyer sees it as a redevelopment target and is just going to demo it anyways. Then it would be bought on a density basis instead of cap rate.
Yes, lease up risk needs to be accounted for in the price.
A vacant building will sell for less than an occupied building due to the risk involved in leasing it up. In a booming submarket with rapid absorption / less competitive supply, the discount will be less because the risk is less. In a dead market where the building has been sitting vacant for years with minimal tenant interest, the discount will be more significant.
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