Utility varies. Think about it this way. If you’re
a company that tools aerospace parts - the electricity feeding a property is
critical because you use it in your operation. Without the amperage - the
parcel is worthless to you. A logistics company that stacks products in a warehouse
relies upon the number of truck doors and inside ceiling height. Therefore -
utility is found in a property with such upgrades. An easy way to consider
utility? Generally, an occupant considering a selection of buildings will place
a greater emphasis on utility or use in its decision. Said occupant is willing
to pay more if the commercial real estate has the features he seeks.
Income production. Rent. How much? How certain? How
long? Easy. Let’s assume a building has market rents and is leased to a Fortune
500 tenant for ten years. So, there is very little risk. The valuation is
simple - an investor will buy the income stream for a price. His price? Easy
math. Annual rent divided by his desired return - also knows as a
capitalization or “cap” rate. Thus, an annual lease payment of $12.00 at a 6%
return yields a value of $200 per square foot. Consequently - your 20,000
square foot building is worth $4,000,000.
If a building is vacant - is it of no value to an investor? If he is
smart - certainly not! However, the analysis is more complex and the stars must
align for the resulting price he can pay to compare to an occupant purchase.
Here’s the way it works. Since an investor relies upon the income - rents - a
property produces, he must calculate what those rents will be, how long it will
take to achieve them, and at what cost. We refer to this as lease origination
expense. If he’s looking at a vacant building and the seller wants $200 per
square foot - the investor must factor in the origination expense. If an
investor can pay the $200, absorb the origination expense, and still get his
return - golden!
If a property is leased - is it worthless to an occupant? It depends.
Keep in mind - an occupant looks at utility. And he must be able to occupy the
building. So, if the PERFECT site - with all the bells and whistles - is
available but leased for awhile - it might still work. Here is how. We recently
represented a buyer. Obligated for two years in a lease - they wanted to pursue
a purchase for their next move. So, if we located a building for sale with a
short term lease in place - that was beneficial. We did! Plus. Because the
lease on the building we bought was short term - the buyer got a better price.
Because - most investors were turned off by the impending lease expiration and
most occupants couldn’t wait two years to move. Boom!
When do the lines cross. We are seeing a fair number
of investors buying vacant buildings these days. Recently - a high percentage
of the structures in a new development in north Orange County were sold to
investors - vacant! Their motivation? Money needed to be spent. Capital had to
be deployed. It was costlier to wait than to buy vacant and incur the
origination expense. A similar trend is occurring inland where new logistics boxes
are trading without tenants in place. The reason? More occupants are seeking
leases vs purchases. As an investor - if you can buy the right utility - your
origination costs are reduced, you create the income, and the world is a happy
place.
