A Basic Primer in Valuation of Commercial Real Estate

I am asked occasionally how value is derived on a commercial property.  Unlike single-family residential real estate a commercial property's value is driven by income:  the more income creation of a commercial property investment the higher the value will be.  Being that this is just a primer I will only be showing value by using the capitalization method of the investment.  The capitalization rate or CAP rate of an investment is in direct proportion to the income generated by the investment.  Here is the basic method of calculating the value of an investment using the CAP rate approach:

 

Potential Rental Income (both income from leases and market rent for vacant units)

Less Vacancies (8-10% of Potential Rental Income)

Equals Gross Operating Income

 

Gross Operating Income

Less Operating Expenses (does not include debt service, commissions or reserves [be sure to include 6% or management fees even if you self manage])

Equals Net Operating Income (NOI)

 

NOI

Divided-by Capitalization (CAP) Rates for the area for specific type of property (for my area I see CAP rates between 5% to 9%)

Equals Value

 

If you adjust NOI up, Value goes up and inverse if NOI goes down.

If you adjust CAP rate higher, Value goes down as a higher CAP rate could potentially be viewed as a more volatile investment.

If you adjust CAP rate lower, Value goes up as a lower CAP rate could potentially be viewed as a stabilized investment.

 

There are more advanced tools used to further analyze a property such as IRR (Internal Rate of Return), which looks as cash flow over a set period of time.  But I won't go into that here.

 

Let me know if you have any questions,

Burt

 

The Industry Insider

I know a lot of you like reading The Industry Insider produced by the National Apartment Association.  Here is the current issue.

Burt

Calculating Capital Gains Taxes in Investment Real Estate

I received the following information regarding the calculation of capital gains taxes from Asset Exchange Company.  I thought it was laid-out simply for most investors to understand.  Please keep in mind that the best way to avoid paying capital gains taxes is to conduct a 1031 exchange.  These types of exchanges have rigid rules governing timing, values, property type and other factors so be sure to pursue tax and legal advice as well as advice from your exchange accommodator.

Burt

 

++++++++++

 

Many property owners are familiar with the “Terrible T’s” in real estate: termites, tenants and trash. Often the “Terrible T’s” become so burdensome that investors decide they want out of real estate altogether.  At that point however, investors become all too familiar with another “Terrible T” – Taxes!  In the state of California, property owners who decide to sell an investment property are subject to the following taxes on gain:

15% Federal Capital Gains Tax

9.3% State of California Tax

25% Federal Depreciation Recapture tax

Calculating the tax bill upon the sale of a property isn’t as hard as one might think, but it does require that you have a firm understanding of how much gain is in the property.  The first thing to understand is how to calculate the Adjusted Basis:

 

Formula	Example
Net Purchase Price	$500,000
(Depreciation)	(100,000)
+Capital Improvements	+25,000
Adjusted Basis	$425,00

 

Once the Adjusted Basis is figured, calculating the Gain is easy: 

 

Formula	Example
Net Sales Price	$1,000,000
(Adjusted Basis)	($425,000)
Gain	$575,000

 

With the gain calculated, tax computations are relatively simple:

 

Tax	Formula
15% Federal Capital Gain	15% * (Gain – Depreciation)
9.3% CA State Tax	9.3% * Gain
25% Depreciation Recapture Tax	25% * Depreciation

 

To defer the capital gains tax liabilities investors have the option of conducting a 1031 Exchange.  For more information regarding the 1031 Exchange process, please call 877-471-1031 or visit www.ax1031.com. Please be advised that this document is not a substitute for professional tax or legal advice.  Asset Exchange Company strongly advises all clients to consult their tax or legal advisors.

New Blog Features: Positive Real Estate News and Your Questions

You may have noticed I made a couple of changes to the blog. At the top of the page you will find links to 10 select stories that I hand-pick throughout the day (as my time permits) from hundreds of real estate related news articles. With all the doom and gloom naysayers out there telling us the negatives in the real estate market, I've decided to focus only the positive aspects of real estate. This is why you will only find news articles addressing the many positive attributes of the real estate market. Here in the blog posting area I plan to discuss the many aspects of real estate from my clients' point of view: the questions, the needs, the wants, the market. Please feel free to ask me a question and I will do my best to address it in a posting.
Burt