My day job is a Director level role at a large commercial real estate firm. Our primary segments are brokerage, management, and development management. I've been doing this for 11 years.
>The story starts with a building operator and a bank deciding what a building is worth. To figure this out, the operator is going to make a financial model that projects the income that a building will generate.
We're going by existing leases at the property, and take into account their expirations and rent escalations. Mostly, we're looking at current income. If a building is valued at $20M because of a $1,000,000 NOI at a 5% cap, that's because it literally has $1,000,000 of yearly income NOW and some seriously high grade tenants to justify that cap. Also, if there are no tenants in the building, we value it by things like construction value. If we're talking about new developments, we usually pre-lease and borrow based on the signed leases.
>You may wonder how the cap rate is determined. The simple answer is the owner and the bank negotiate and agree on a number.
This is disingenuous. We don't pull a cap rate out of thin air. We go by market caps on comparable properties and also factor in the credit of the existing tenants and their lease terms. There is a tiny bit of back and forth on the cap if the buyer and the bank disagree but this a matter of tenths of a percent.
All of that said, I have never known a property owner who refused to lower rents in a game of chicken with the bank and most would certainly rather fill a space with someone than keep rents elevated. If a space is empty, it's generating zero income, your NOI is therefore lower, and the building value has already decreased. The bank isn't pretending it's worth more than it is because you're advertising a certain rate. They're just giving you more time to lease the space so it doesn't have to go into receivership, which is a loss for everyone.
Beyond that, most leases are signed at or below asking rent unless the area is extremely high demand. They may not be advertising a rate drop, but anyone in this business knows that asking rents are a point to be negotiated during the leasing process.
>The story starts with a building operator and a bank deciding what a building is worth. To figure this out, the operator is going to make a financial model that projects the income that a building will generate.
We're going by existing leases at the property, and take into account their expirations and rent escalations. Mostly, we're looking at current income. If a building is valued at $20M because of a $1,000,000 NOI at a 5% cap, that's because it literally has $1,000,000 of yearly income NOW and some seriously high grade tenants to justify that cap. Also, if there are no tenants in the building, we value it by things like construction value. If we're talking about new developments, we usually pre-lease and borrow based on the signed leases.
>You may wonder how the cap rate is determined. The simple answer is the owner and the bank negotiate and agree on a number.
This is disingenuous. We don't pull a cap rate out of thin air. We go by market caps on comparable properties and also factor in the credit of the existing tenants and their lease terms. There is a tiny bit of back and forth on the cap if the buyer and the bank disagree but this a matter of tenths of a percent.
All of that said, I have never known a property owner who refused to lower rents in a game of chicken with the bank and most would certainly rather fill a space with someone than keep rents elevated. If a space is empty, it's generating zero income, your NOI is therefore lower, and the building value has already decreased. The bank isn't pretending it's worth more than it is because you're advertising a certain rate. They're just giving you more time to lease the space so it doesn't have to go into receivership, which is a loss for everyone.
Beyond that, most leases are signed at or below asking rent unless the area is extremely high demand. They may not be advertising a rate drop, but anyone in this business knows that asking rents are a point to be negotiated during the leasing process.