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In determining your value today the exit CAP rate assumption would have to be no less than 8.5%. A recent CoStar study shows that the mean CAP rate for the past 20 years in commercial real estate properties has been about 8.5%. During the correction in the early 1990’s the CAP rate surpassed 8.5% and reached as high as 10-11% and then settled back down to about 8.5. It wasn’t until the early 2000’s with the tidal wave of credit and money flowing into commercial real estate, that CAP rates compressed as low as 5%. Now they’re going up.
A prudent buyer will plan on a vacancy carry of at least 20 months. If you’re going to buy a commercial real estate asset today with significant vacancy, plan on carrying it for the next 20 months, at a minimum. You should also price rent reductions of 20-30% into your cash flow analysis to allow for the re-pricing that’s taking effect today.
Your discount rate should align with market expectations. Sophisticated commercial real estate buyers are chasing paper where they’re earning 12-13% returns. In order for buyers to be attracted to the risks with owning and operating commercial real estate, the returns must be higher, which means you should plan on at least a 15% discount rate for the term of your investment. Discount your projected sales price and periodic cash flows at 15+% to today’s present value. There’s your number.
Happy Investing!
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