Valuing Vacant Space

Has the market returned to valuing vacant space?  If so, is it because investors are more confident that the commercial rest estate (CRE) market has reached the bottom and is on the uptick or is it because buyers, frustrated by the bid/ask gap and sellers seeming unwillingness to reduce the asking price, are being forced to rationalize higher prices therefore positioning themselves to do deals?

Amid signs that the CRE market continues to languish including CMBS default rates projected to hit 12% this year, lack of available credit, the on-going weak job market and the lack of both investor and consumer confidence, the fact that investors have of recent been willing to assign some value to vacant space is a hopeful sign that a bullish view of the CRE market, albeit tepid at best, has returned.

Less than a year ago, we saw offers for CRE, where there was an above market level of vacancy, based on a cap rate applied to existing NOI (trailing 12 months) only.  In some cases, particularly for retail properties, the value for occupied space was arrived at by applying a discount rate only to the remaining lease terms of the existing leases.  More recently however, we have seen buyers willing to accept a below market initial return, say 5-6%, and given their return criteria of 9% or more, recognize that the “up” can only be achieved through leasing vacant space.

The market has effectively given the vacant space value, assumed the lease-up risk and exhibited some level of confidence that a higher occupancy level can be achieved.  Only time will tell whether the assumptions and risk are justified or whether it’s simply a reality that buyers have been forced to accept in order to satisfy their need to do deals.

Source: Tim Buss, CCIM is Senior Vice President-Special Asset Solutions at NAI Global.