Problem 8-4

Valuing Commercial Real Estate BuildingOne 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. BuildingOne has gathered general information about the two buildings, including valuation information for building A:

Buildings A and B are similar in size (80,000 and 90,000 square feet, respectively). However, the two buildings differ both in maintenance costs ($23 and $30 per square foot) and rental rates ($100 versus $120 per square foot). 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 value of building B using data based on the sale of building A. Building A sold for $462 per square foot, or $36,960,000. This reflects a sales multiple of six times the buildings net operating income (NOI) of $6,160,000 per year and a capitalization rate of 16.67%.

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

2. 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 BuildingOne place on building Bs maintenance costs? How much value should BuildingOne place on building Bs revenues and, consequently, on the firm?

uilding size (Sq. ft.) Rent Maintenance (fixed cost) Net Operating Income Per Square Foot 100 (23) 77 120 (30) 90 Total Square Footage 90,000 80,000 8,000,000 10,800,000 (2,700,000) (1,840,000) 6,160,000 8,100,000