The most common method of valuing commercial property is the least accurate, because it only works if all properties have the same characteristics. Called the Sales Approach, it requires gathering the sales price of nearby comparable property, then making adjustments for different traits. This leads to inaccuracy, since the unique quality of real estate is that location can contribute greatly to how a property is used which determines what its value might be, and no two properties can occupy the same location. Other characteristics such as floor plan, parking, zoning, ingress and egress can also contribute greatly to value.
Sometimes, owners value real estate based on what they paid for it, or what someone last offered for the property, or the cost to build the property new. In reality, the cost of property has little to do with market value, and an offer made by one buyer does not mean a different buyer would value the property at the same price. The market value is the price a property would bring in an open and competitive market, with a willing buyer and seller knowledgeable about the facts. The cost approach works when you have the time, financing and a reliable contractor to build an alternative structure.
Whether you own stocks or bonds or real estate, the best method of valuing an asset is the present value of all future cash flows. The underlying principal is that a dollar one year from now is worth less than one dollar today, because you could invest that dollar today at some interest rate which will grow in one year to a value of more than one dollar. Here is the math:
Let’s put this information to work and say a property delivers $10,000 annually in Cash Flow After Taxes. The current value is the sum of future cash flows. You calculate each year’s cash flow, discounted back at an interest rate you could earn on other investments. Let’s assume 7 years at a 5% interest rate and change the n value to match the number of years in the future.
In summary, $57,861 today is the same as $10,000 for 7 years, assuming 5% interest rates. Therefore, if a property had a 7 year lease that produced income of $10,000 annually, the current value of that lease income alone would have a value of $57,861. If an investor required a 10% rate of return, he or she would be willing to pay $578,610 for the property, just to get the lease income.
Not all income is the same however. Let's examine how to determine cash flow income.
With commercial real estate, the best measure of income is called Cash Flow After Tax, and here is how it is derived.
- Vacancy and Credit Losses
- Operating Expenses
- Annual Debt Service
- Tax Liability
= Cash Flow After Taxes
Source: CCIM Financial Analysis, "The Appraisal of Real Estate", 14th edition, Mark Rattermann, MAI, SRA.
Determining accurate prices for commercial real estate can be elusive. It's not what economist call a highly competitive market such as buying a stock or a bond where the bid (highest price for buyer) and ask (lowest price for seller) is actively visible for all to see. Market prices for commercial real estate can be vastly different from appraisal valuations and can vary widely by property type, location and tenant. The unpredictability of determining a price means that the person with the most knowledge makes the best decision and capitalizes on the opportunity that others may not recognize. This article researches the commercial property markets in Louisiana and Mississippi to provide the knowledge with which you can make better commercial real estate decisions.
For $4.2 billion, you can buy all the listed commercial property in Louisiana. There are 26.9 million square feet for sale and 24.2 million for lease.
There are 8 sectors of commercial property, shown below. The time it takes to sell or lease most of these 8 types of property is longer than the gestation period of most animals, ranging from 144 to 596 days. Only Apartments and Retail property can be leased or sold faster than it takes to give birth to a human.
Average prices for space for lease and for sale are listed in the table below. The tightest sector is recognized by how close to the list price the transaction takes place. With 700 transactions, Shopping Centers rank the highest demand, having an average transaction at only 6.9% below their list price, followed by 2,493 transactions in the Office sector averaging only 10% below list, land at 15%, Industrial at 16% and in last place is the Retail market that averages a transaction 20% below list.
Louisiana is 4 times the Mississippi market size in property for sale, and 9 times the size in property for lease.
The average lease rate in Louisiana is only 10 to 20 percent higher than in Mississippi, but the average sale price in every significant sector is 30 to 100 percent higher. This is due to the more vibrant economy and demographics which drive commercial property to produce more income and therefore hold more value. For example, Industrial sale prices average $34 per square foot in Louisiana compared to $15 PSF in Mississippi, and Office property averages $80 PSF compared to $63 PSF, Retail averages $94 PSF compared to only $48 PSF, and Shopping Centers average $88 PSF compared to $43 PSF.
We examine a city's MSA, which is the Metropolitan Statistical Area, designated by the Census Bureau and defined by the Office of Management and Budget as an area with a high degree of social and economic integration . New Orleans MSA is the larger market measured by square feet for sale, with 8.4 million vs. 5.7 million in Baton Rouge, but Baton Rouge is the larger market by total sale price with $1.3 billion vs. $1.1 billion.
New Orleans has more properties on the market than Baton Rouge in every significant sector. Office and Industrial sector lease and sale prices are very close in both cities, but 371 transactions in Retail averaged a 46 percent higher price in Baton Rouge while 261 Shopping Center transactions occurred at an average 25 percent lower. Since there were hundreds of transactions, the price data cannot be skewed by outliers.
Who would have thought Gulfport even had an MSA. The market is about 13 percent of the size of New Orleans, as measured by square footage for sale and 6 percent of the market size as measured by lease space. Prices per square foot are within 10 percent of the New Orleans market for the Industrial, Office and Retail sectors, but average 57 percent of the Shopping Center lease price. Sale prices are 20 percent higher for Industrial due to a shortage in supply, but Retail and Office sale prices average 10 to 20 percent lower.
Now that we have the average sale and lease prices of the various sectors in major markets in both Louisiana and Mississippi, where is the opportunity? If you own properties in several cities, it is called arbitrage, but the average person must look for areas and sectors where prices are simply out of sync.
You might think Shopping Centers in Baton Rouge are a steal at a sale price 26 percent less than in New Orleans, but lease rates are 26 percent less also. That's no coincidence. Office property in Baton Rouge is a bargain compared to New Orleans; even though lease rates are 3 percent less, sale prices are 14 percent less. The real bargain is Retail in New Orleans which has 12 percent higher lease rates than Baton Rouge but sale prices averaging 32 percent less.
For more information on prices on commercial real estate, click on these articles:
Office Space Prices In New Orleans
How To Value Commercial Real Estate
In Louisiana, there is 26.9 million square feet of commercial space for sale and 24.2 million square feet for lease, which can be broken down into these major categories:
INDUSTRIAL: The Industrial sector has 926 properties totaling 21.1 million square feet and an average asking sale price of $34 per square foot and average lease rate of $4.77 per square foot. The average property is on the market an astounding 460 days.
OFFICE: The Office sector has a population of 2,493 properties with and average sale price of $80 per square foot and average lease price of $15 per square foot and on the market an average of 293 days.
RETAIL: Comprises 1,476 properties averaging $94 PSF in sale price and $12.76 PSF for lease with 266 days on the market.
SHOPPING CENTER: Classified by most as part of the Retail sector, but separated out here as 700 properties averaging a sale price of $88 PSF and lease price of $15.87 PSF with 596 days on the market.
LAND: The largest sector with 1.7 billion square feet and 2,570 properties averaging a sale price of $1.43 PSF and lease price of $1.65 PSF. Seems like its a no-brainer to buy the land at $1.43 PSF and lease it out at $1.65 PSF but it takes so long to transact a deal that the Average Days On The Market does not even show in records. It can take decades to lease or sell land.
MULTI-FAMILY: 102 properties averaging a sale price of $38 PSF , although most are sold based on Net Operating Income or Price Per Unit. Multi-Family is the category in the highest demand, as witnessed by the lowest days on the market at 144. Since the recession in 2008 and the housing market collapse, it has required a higher deposit to purchase a home, causing an increase in renting, resulting in a higher demand for apartments, which leads to higher occupancy rates, which results in large institutions changing their asset allocation away from shopping center investment to apartments, which causes a shift in demand leading to higher prices for apartments and lower Capitalization Rates. Whoo! Yes, it is a Domino Effect, and the trend will continue.
Industrial Market In DetailLet's carve out one of the sectors comprising all Louisiana commercial real estate and break it down. The Industrial market is comprised of 926 properties with 570 for lease and 356 for sale. There is 10 million square feet for lease and about the same for sale. On average the last two years, 29 properties have been leased at an average of $3.68 per square foot and 10 properties have sold at an average of $46 per square foot. This is an average of all the industrial properties in Louisiana, and certain areas may be stronger or weaker.
Just like the analyst on Bloomberg and CNN who prognosticate with 100% accuracy that the markets will be volatile and fluctuate, providing no more insight than a zoo animal throwing a dart, the chart below shows that over the last 2 years the price of leasing Industrial space on average in Louisiana has gone up and down but not gone anywhere at about $4 per square foot. The average days on the market ended up where they began at around 300.
Tune in next week for a detailed look at prices of other sectors of commercial real estate in Louisiana.
For more information on prices on commercial real estate, click on these articles:
Office Space Prices In New Orleans
5 Things You Need To Know About Pricing Multi-Family
How To Value Commercial Real Estate
