Cap Rate - On A Vacant Building
I am a SFH Investor in South Africa that is now in the process of moving into the convertion of Commercial Real Estate.
I want to purchase a Commerial Office Block in the Central Business District of Pretoria and convert it to apartments. However - this building has been standing vancant for some time.
How do I determine the Cap Rate on a vacant building?
Please help
Peter de Beer
[addsig]
Cap rate is a function of Net Operating income. Therefore a vacant building has a negative cap rate. It is not a useful factor to consider when dealing with vacant property.
You can calculate a pro forma cap rate by first coming up with a pro forma(or projected ) income and expense statement for the building and then dividing your costs (acquisition and renovation) into the pro forma Net Operating Income.
Commercial King
Thanks for the reply
1.) Price = NOI/ Cap Rate - Correct?
2) Does this mean that I should determine a Proforma NOI - based on similar properties ?
3) The price would then be the Current Asking Price which would determine the Cap rate?
4) If Cap rate is above 10% it might be a good buy for below 10% one needs to look at other options.
I would value your comments on 1) to 4)
Regards
Peter
[addsig]
1) correct. Noi/price = Cap. you may solve for any function using normal algebra.
2) Yes, that would be one way to get pro-forma numbers. There are others as well. You can, for example, calculate most of the expense numbers using formulas of one sort or another. Heating/cooling costs are often available on a $/sq. ft. basis, for example.
3) No, in these examples Price would be equal to an after renovation value. In order to calculate back to a current value you must first subtract from that after-renovation value your cost of renovation, your cost to hold the property during the renovation and leasing/selling period and some reasonable (or not) amount of profit for taking the risk of doing the project.
4) In a development project of the sort you seem to be describing I would probably shoot for a cap rate based on my cost of at least 15% (I'd prefer higher than that) then I would probably sell the property at a 10 cap.
I guess the basic thing I would like to say here is that the cap rate works best when you are talking about up-and-running properties with rental income. While it is possible to use it as a tool in the analysis of a renovation project that is not really what it is meant for.
Conversion of offices into residential has been very profitable in the states in the last few years. Tell me about the Praetoria market? I have good friends in Joburg and keep thinking I may try to make a trip there someday. But not this year.
Commercial King
Thanks for your VALUED advice ! I appreciate the time you spend in explaining all the detail - Thanks.
Pretoria - like JoBurg experienced a total decline in property values after our change in goverment in 1994. Our intention is to risk the upliftment of the property in the CBD Area.
Which we had your Financial Analysis Experience here!
Peter
[addsig]