Problem 8.2 Valuing Commercial real estate

Building One properties is a limited partnership formed with the express purpose of investing in commercial real estate. The firm is currently considering the acquisition of an office building that we refer to simply as Building B. Building B is very similar to Building A, which recently sold for $36,960,000.

Building One has gathered general information about the two buildings, including valuation information for building A:

Building A and B are similar in size (80,000 and 90,000 sq. ft.). However, the two buildings differ both in maintenance cost and rental rates. At this point, we do not know why these differences exist. Nonetheless, the differences are real and should somehow be “accounted for” in the analysis of the Building B using data based on the sale of Building A.

Building A sold for $462 per sq. ft. or $36,960,000. This reflects a sales multiple of six times the building’s net operating income (NOI) of $6,160,000 per year and a capitalization rate of 16.67%.

a. Using the multiple of operating income, determine what value BuildingOne should place on building.

b. If the risk-free rate of interest is 5.5% and the building maintenance costs are known with a high degree of certainty, what value should Building One place on Building B’s maintenance costs? How much value should Building One place on Building B’s revenues and consequently, on the firm?