The following Q&A was completed as part of our conversational Commercial Real Estate FAQ Interview Series, we hope you find it helpful:
There are couple different factors that go into valuing retail commercial property. First, one wants to take a look at the cap rate, and dividing your earnings by price. Next, an investor wants to consider the cost per square foot, and how this relates to the replacement prices needed to keep up with the property and its tenants.
Richard Wilson: So, how do you value retail commercial property? A lot of investors who may be listening to this might be familiar with valuing multi-family properties, for example, but have never looked at investing in retail before. How do you value those types of properties typically?
S.L. Van Der Zanden: The simple answer is, like most commercial real estate, we look at the cap rate, and we also look at the cost per square foot. Number one is the cap rate, which is basically the reverse of the P ratio because you’re dividing the earnings by the price. That’s where most people hang their hat. The price per square foot then you want to look at as it relates to your replacement cost – what is it going to cost to repair the building and re-tenant it? It’s not just the physical cost but it’s getting the tenants, it’s paying for the TEI and the commissions, and getting it leased up, which takes a period of time. So you don’t want to get really out of whack. When you’re dealing with triple A properties, they sell for numbers that are way beyond replacement costs, but you have to trust that the location is strong enough that you’re always going to be able to have replacement tenants that pay those kinds of rents. Those are the two main ways of looking at valuation for retail.
Richard: Okay, great.